Optimistic, but not euphoric, is how Stefan Kreuzkamp describes his outlook for the international financial markets over the coming year. Yields only in the mid single figures is the best that can be expected right across all asset classes, according to the Chief Investment Officer at Deutsche Asset Management. Correct selection and diversification of investments will be even more important than last year. In principle, Deutsche AM favours investments with strong income components – such as good payers of dividends, selected higher-yield bonds as well as alternative infrastructure and real estate investments. “We are not pinning our hopes for economic growth and capital market returns very high for 2017. Having said that, we have no concerns that we will see recession in the major economic regions. However, political and central bank actions may continue to prompt short-term dips in the market,” said Kreuzkamp.

The political scene remains the biggest unknown in Kreuzkamp’s view: the unresolved Brexit issue and elections in some key European countries mean that the spotlight is firmly back on the future of the European Union (EU) as well as nationalism and protectionism. In recent times, EU opponents have gained some ground. Regional conflicts, such as Syria and Eastern Ukraine, continue to inflate and to rage. This is topped by Russian and Chinese foreign policy ambitions.

Politics shapes markets

Kreuzkamp believes that developments in the US are extremely important. In his view, President-elect Donald Trump is entirely capable of shaping the markets in a sustained way. This is especially true as a Republican-dominated congress could grant him considerable room for maneuver. “A combination of tax cuts, deregulation and infrastructure projects could stimulate the US economy to the extent that this boost could continue for eight or even nine years. But this will bring inflation,” said Kreuzkamp.

The financial markets have already given their initial reactions. But it is also conceivable that investor enthusiasm could soon fade somewhat. On the one hand, this could be the result of plans will not be executed as quickly as many in the markets would hope, and on the other hand, the flip side of Trump’s policies could rear its head again – for example restrictions on free global trade. But it is a matter of pure speculation if Trump really will, or will be able to, pursue protectionism – isolation would squeeze the competitiveness of American companies if costs were to increase. In this respect, Deutsche AM expects to see the pace of growth and inflation pick up only slightly during 2017. “We will be reviewing all our positions regularly in line with US political developments. We are fully aware of the President-elect’s potential to surprise – in both directions. Politics shapes markets”, explained Kreuzkamp.

In global terms, he expects to see growth of 3.5 per cent, which would make 2017 the eighth consecutive year with growth above 3 per cent – something last seen in the 1960s. An economic upturn is also expected in the Eurozone. For 2017, Deutsche AM expects to see growth of 1.3 per cent – mainly driven by consumption.  

Strong dollar

In the bond and currency arena, this coming year will initially be marked by even more divergence in central bank policies with a knock-on impact for the US dollar. Two further interest rate hikes are anticipated in the US – following the move in December 2016 – yet the EU is expected to remain at its low levels and continue to actively pursue its bond buy-back program well into next year. Nevertheless the so-called tapering phase may then begin.

Next year the expectation is that the US dollar will remain strong. “We are assuming that the lowest interest rate is now behind us, but we are not counting on sustained increases. In 2017, key European countries and the US are likely to see negative overall yields from sovereign bonds. Interest rate divergence between the Eurozone and the US is likely to increase. In the medium term, we are not convinced that this era of very low interest rates is at an end, although 2016 may well have marked the lowest point for interest rates,” said Bill Chepolis, Head of Fixed Income EMEA at Deutsche AM. From an investment point of view, Deutsche AM continues to pursue its preference for corporate bonds in Europe and the US, as well as sovereign bonds from peripheral European countries. Within the emerging markets grouping, there are attractive hard currency sovereign bonds, even if these are subject to a higher level of price volatility.

Manage risk actively

Deutsche AM estimates the international equity markets will achieve single digit growth, but the situation differs widely across the important markets with US indices recently setting new records. Unfortunately any prognosis remains very difficult because of the uncertainty surrounding Trump policy. US equities could indeed benefit from deregulation and a new fiscal program, but this could be subdued by a strong dollar and wage pressures. Rising interest rates would tend to preclude increasing equity prices. In emerging markets, a higher US interest rate is just one issue that could fuel uncertainty. Having said that, emerging markets are witnessing an economic recovery which could benefit European equities, most especially in Germany, emphasised Thomas Schüssler, designated Co-Head of Equities at Deutsche AM. He points out that recent corporate figures out of Europe have started to look promising again. At the moment, stock exchanges have priced in a degree of political risk which explains the gap in valuations with the US. However, Schüssler believes it is precisely this that offers potential for a positive surprise.

Overall, volatile and sideways-moving markets tend to be a rich source of opportunities if investors are active, selective and tactical. In particular multi-asset investments should prompt considerable demand from investors: “With prospects of returns so poor, investors have to be prepared to actively manage risk – in the year to come this will be the key to successful investment. The challenge lies in optimising the risk versus a stated return objective”, said Christian Hille, Head of Multi Asset at Deutsche AM.