Out-of-sync global growth appears apt to continue in 2017, much as we have seen in the past few years. In our view, incremental improvement in global economic output should be supported by a combination of slow-but-steady consumer spending, employment and household formation in the United States, together with improvements in EMs and continued accommodative monetary policies by non-US central banks. Although the US economy technically enters its eighth year of economic expansion in 2017, we believe it is likely to continue to expand modestly in the near term. In our analysis, conditions such as excesses in capital investment or the housing market are not yet in place to foster a conventional investment cycle-driven recession.
While the pace of economic growth may remain relatively subdued, we see reasons for optimism in US and global equity markets in 2017, even as investor uncertainties over commodity prices and upward-trending US interest rates will likely persist. Low global growth may prompt further fiscal stimulus efforts in DMs outside the United States. We also anticipate longer-term economic rebalancing in EMs and structural reforms. Many DMs are contending with disinflationary pressures. Subsiding inflation in EMs leaves room for monetary policy flexibility, in contrast to their developed counterparts, where central banks appear to have exhausted operational tools. In the United States, hints of wage growth, encouraging employment data and an overall build in key inflation gauges have led to growing market sentiment that the Fed is on track to raise interest rates in 2017, though the path is uncertain and will remain data dependent.
Outside the United States, the path to higher rates is less clear. Global debt levels are at historically high levels as global economic growth has remained tepid. The consensus view appears to be that to bolster growth while also reducing debt, fiscal stimulus should be used to spark inflation along with financial repression to keep real interest rates negative. After years of austerity, ECB President Mario Draghi recently appealed for more expansive budgetary policy. Meanwhile, Japanese policymakers announced a fiscal stimulus package, and the BOJ commenced efforts to engineer a steeper yield curve (i.e., increase the differential between longer-term and shorter-term government bond yields). Even with these policy shifts, the long-term risks to growth due to Brexit and other geopolitical challenges remain to be seen.
EMs also present risks and opportunities, in our view. China’s ongoing rebalancing from investment-led to consumption-led growth will likely lead to a continued slowdown in its still-powerful economic engine over the near term as the country manages the transition. Meanwhile, the recession in Latin America might find fresh relief from a mild recovery in commodity prices and generally easier financial conditions. Sanctions have played a role in the collapse of Russia’s petro economy and negative gross domestic product (GDP), and Brazil’s protracted period of tremendous political upheaval has impacted its economy quite significantly. However, the broader components of EM economies—such as the important developing countries outside China, a list that includes Malaysia, the Philippines and Indonesia—intrigue us. In South America, we think Mexico, Chile and Peru offer a much different and more constructive outlook. And while Russia and Brazil may have been key detractors to global GDP growth in 2016, we are optimistic that these countries could potentially outpace investors’ low expectations for growth in 2017.
As we reflect on 2016, one of the key themes that emerged was unpredictability. January and February brought negative volatility followed by a swift, albeit narrow, market recovery. Brexit and the heightened political uncertainty tied to the US election cycle also contributed to uncertainty. Events such as these, while analyzable at some level, are very difficult to predict. However, bouts of volatility often create opportunities for longer-term investors with a staunch fundamental focus to take advantage of dislocations in equity markets.
Through it all, fundamental analysis and bottom-up stockpicking have remained the primary focus for many of our investment teams, while sector-specific insights from our seasoned team of analysts across the globe sharpen our views on the year ahead. Despite the uncertainty surrounding the pace of global economic growth and the duration of the current economic expansion, we regard numerous factors as supportive of equities across geographies and sectors, offering investors the potential for multiple opportunities in the year ahead.
By Edward D. Perks, CFA Chief Investment Officer, Franklin Templeton Equity
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