It’s a big world out there, and investors in international equities can sometimes feel like they’re being tossed about by crosswinds. During the past 12 months, rock-bottom interest rates, weak commodity prices, worries about China and the continued strength of the U.S. dollar all contributed to a volatile investing environment.
But global investing is an important part of a diversified portfolio. For starters, a globally diversified portfolio may reduce risk. It can also offer investors return potential. As an investor, you never know which types of investments are going to outperform in any given year. Take 2016 for example. While it’s been a bumpy year to date for developed market investors, those who maintained their exposure to emerging markets were rewarded. The MSCI Emerging Market Index has returned 6.41% as of June 30.
So what’s ahead for next year? While markets are unpredictable, here are six trends that we believe are likely to shape global markets in 2017.
Trend 1: Revival of earnings growth
We’ve seen an upturn in global earnings forecasts since February. Stock analysts seem to be catching up with surprisingly solid global economic data.
This trend can be seen across most sectors. Earnings expectations for stocks in the industrials, energy, materials, consumer staples and information technology sectors have recently rebounded. These sectors join health care, utilities and telecom, which have had an improving outlook since the spring. The two holdouts are the consumer discretionary sector, which remains flat, and financials, which is still in a downward trend.
Stocks have benefitted from rising earnings estimates, even in the face of some negative geopolitical developments this summer. However, without stronger global economic growth, earnings may stabilize but are unlikely to post a powerful rebound.
Trend 2: Political populism’s rise
Anti-establishment populism was a global theme this year, with nontraditional political candidates looking to ride waves of voter discontent to polling success in the United States, Europe and elsewhere. The U.K. was also buffeted by “Brexit”—its surprising vote to leave the European Union—in late June.
The prospect of a populist leader can easily rattle markets, but are there long-term effects? It’s worth looking at recent examples: France elected a Socialist Party president in 2012, and Greece voted in the radical-left party Syriza in 2015. But instead of fulfilling their campaign promises to defend pensions and other benefits, both governments adopted tax cuts, labor reforms, lower trade barriers, budget austerity and other concessions needed to put their economies on stronger ground.
With elections due to take place in Germany and France in the coming year, that’s a lesson for U.S. investors who may think that sweeping political change means sweeping economic change: History usually says otherwise.
Trend 3: The strength of the U.S. dollar
After reaching a nine-year high in late 2015,1 the U.S. dollar has taken a more erratic path in 2016, due in part to the Federal Reserve’s hesitancy to raise interest rates and unexpected events like the Brexit vote.
A sharply strengthening dollar could prove a drag on U.S. growth going forward. A much stronger dollar could hurt foreign demand for American products, which could eventually lead to lower production at home. And American companies that do a lot of business overseas could see their earnings erode when they convert profits into U.S. dollars.
A stronger dollar could also be a problem for emerging market countries for two main reasons. First, while weaker emerging market currencies relative to the dollar could boost exports, they could also lead to unwanted inflation. Second, emerging market borrowers with debt denominated in U.S. dollars could struggle to pay their debt as the value of their currency weakens. Watching the path of the dollar will be critical for these investments in the year ahead.
Trend 4: The limitations of negative interest rates
Desperate to stimulate economic growth, central banks in Japan, the eurozone, Sweden, Switzerland and Denmark have driven their interest rates into negative territory in an attempt to promote lending and revive inflation. Interest rates have fallen so low around the world that in some cases investors may find themselves paying to hold foreign bonds, rather than being paid to do so.
Financial services firms in such economies, which now must pay to hold some of their reserves at central banks, could feel the crunch. While negative rates certainly give them an incentive to lend more, they’re also a drag on earnings. In the end, the shift to negative interest rates could actually work against policymakers’ desire to boost lending. Also, savers could pull their money from banks and bonds and stuff it under their mattresses, starving these economies of funding. The impact of these uncharted policies will continue to play out in 2017.
Trend 5: Oil price volatility
Overproduction has weighed heavily on oil prices, which fell from more than $110 a barrel in June 2014 to about $25 in January 2016.2 The rising dollar played a role, too. Like most globally traded commodities, crude oil is priced in U.S. dollars, so a rising dollar effectively makes the commodity more expensive for foreign buyers, which can hurt demand and further weigh down prices.
Plunging oil prices have hurt oil-dependent countries such as Saudi Arabia, Russia and Venezuela. In the United States, energy companies cut back operations as oil prices dropped below the break-even cost of production. Some went bankrupt. For those that did not, questions remained about how cash-strapped energy companies would make payments on the large amounts of high-yield corporate debt many had taken on during the boom years.
Concerns eased when oil prices bounced back to around $45 a barrel, but a renewed decline would revive those fears and put oil-dependent economies at increased risk.
Trend 6: China’s changing economic engine
The growth trajectory of the world’s second-largest economy (after the United States) is clearly important—especially to countries like Japan and Australia, whose top trading partner is China, and to emerging market countries that supply the commodities China consumes.
For the past few years, China’s growth has been gradually slowing as it transitions from a manufacturing-based economy to one focused more on services and consumer spending. However, markets were shaken in August 2015 when China suddenly devalued its currency, the yuan. U.S. markets tumbled, too, as investors around the world worried that China’s economy was weaker than expected and could pull the rest of the world into a global recession.
Since then, however, China’s economy has been boosted by fiscal and monetary stimulus, while construction has rebounded due to increased government-led infrastructure spending. This stabilization has been positive for global growth. In 2017 it will be important to watch whether China continues to rely on debt-fueled construction or renews its focus on becoming a consumer-driven economy.
Thinking about the opportunity
All of these themes will be critical to watch in the year ahead. But investors should keep in mind that risk isn’t just something no one thought would happen that did. It’s also the event that everyone thought would happen that didn’t. The dashed expectations for Fed rate hikes in 2016 contributed to the reversal in the dollar and oil and helped power a rally in emerging market stocks. Maintaining a globally diversified portfolio can help to mitigate the impact of surprises and capture opportunities.
1Based on the U.S. Dollar Currency Index (USDX, DXY), which measures the value of the U.S. dollar relative to a basket of foreign currencies including the euro, Japanese yen, British pound sterling, Canadian dollar, Swedish krona and Swiss franc.
2 Bloomberg, based on closing prices for ICE Brent crude futures contract, 01/2016.