Top Three Things on Managers' Minds for 2017 (Part 1)

2016 was certainly the year of surprises – with Brexit and Trump shocking the world. Yet, besides short-lived market sell-offs, global markets were relatively resilient. So what might be on the horizon for investors in 2017?

Equity, Fixed Income, and Sustainable Investing managers share their top issues and opportunities, along with a potential market surprise for investing in the new year.

Our Panel Responses

Bill Nygren
Bill Nygren, CFA®

Partner and Portfolio Manager Harris Associates

1. Anemic growth? For several years, we’ve been anticipating that global growth would return to near the pre-Global Financial Crisis levels. And each year the World Bank started out by projecting that reasonable growth was just around the corner. Then as the year progressed, they had to consistently cut their expectations. Low growth has allowed interest rates to remain at near-zero levels, has allowed commodity prices to remain below prices needed to justify new exploration, and has resulted in the earnings of cyclical companies being below trend.

2. Growth momentum? If 2017 is finally the year when growth surprises to the upside, it would likely be accompanied by very different sectors leading the stock market. That is why we favor companies that may benefit from rising interest rates (banks and other financial companies), rising commodity prices (energy companies), and higher earnings from industrial cyclicals.

3. Unknowns of Trump administration. The US political scene will be of key importance in determining whether or not global growth accelerates. Throughout a very nasty presidential campaign, many policies were promised from the prevailing party that were both pro-growth and anti-growth. If the new Trump administration focuses on tax reform and reducing the burden from regulations, the result would likely be a meaningful increase in growth. If instead the focus is on restricting global trade and deporting illegal immigrants, growth would likely decrease. We believe the likelihood is much higher that pro-growth policies will prevail, but would also add that over many years the forces of global growth have proven strong enough to overcome misguided government policies. As long-term investors, we believe the valuations are compelling for the companies that would most benefit from renewed economic strength.

One surprise that could catch us off guard
A return to growth could create a very unpleasant surprise for many investors, as investments widely perceived as safe could be riskier than those perceived as risky. Investors tend to look at the risk of a stock as being the potential deviation of earnings from the anticipated level, and pay little attention to price. We have been saying for some time that low-volatility businesses priced at historically high relative P/E ratios are riskier than higher-volatility businesses priced at low relative P/Es. With interest rates so low, the stable, low-growth businesses that pay out a high percentage of profits as dividends have become favorite “bond substitutes” for investors seeking higher yield than is available in the bond market. These companies have typically been priced at lower-than-average P/Es, but today sell at substantial premiums. Even if the businesses perform about as expected, there is substantial risk should the P/E ratios revert to their long-term averages. If interest rates rise, as we expect, then P/E reversion is the likely outcome. This is why we currently find most electric utilities, telecom providers, or US-based consumer packaged goods businesses unattractive.

Additionally, in a higher interest rate environment, stocks would likely prove less risky than the long-term bonds that investors have bid up to historically low yields. 2017 could be a year that turns investor thinking about risk upside down.
Bill Nygren, CFA®, is a Partner and Portfolio Manager at Harris Associates.

William Nygren is a Partner and Portfolio Manager at Harris Associates L.P. He joined Harris Associates in 1983 as an investment analyst and later served as the firm’s director of research. Previously, he was an investment analyst with Northwestern Mutual Life Insurance Company. Mr. Nygren has received many accolades during his investment career, including being named Morningstar's Domestic Stock Manager of the Year for 2001.

Mr. Nygren earned a BS in accounting from the University of Minnesota (1980) and an MS in finance from the University of Wisconsin – Madison’s Applied Security Analysis Program (1981). He is a CFA® charterholder.

Elaine M. Stokes
Elaine M. Stokes

Vice President and Portfolio Manager Loomis, Sayles & Company

As we look forward into the new year, the three things most on my mind are coping, crisis and the credit cycle.

Across the globe, as populations continue to move down a divisive Nationalist path, we should expect to see people struggling to cope with the realities of a less friendly and accepting world. There are very real tensions and human rights issues being brought to the forefront, leaving a new generation to face hard realities head on. In country after country, we are seeing the extremes gain traction while the middle ground gets hollowed out. This will cause challenges for governing bodies to keep unrest at bay and bring policy focus internal. Is this a healthy environment to spur stronger growth? Are the days of central bank cooperation behind us? Is this the one step back for global trade after two big steps forward over the past few decades?

We will need to be ever aware of the increasing pressures building within societies as we move away from cooperation and acceptance toward building walls, refocused nation states and cyber everything. With policies leaning protectionist, continued terror threats, border skirmishes erupting, and nation states flexing their muscles while others look inward, miscommunication and misinterpretation of actions are far more likely to happen, as well as the risk of someone acting rogue out of anger. Geopolitical and humanitarian crisis are realities in this environment.

All of this is in the background for the new slate of policies being thrown at the sluggish economic growth enveloping the developed world. Will this new direction in policy – aggressive fiscal policy – be the answer as we sit in an elongated late cycle environment, or will it prove to be too much too late and push us into a more violent downturn? Just how long will the good times roll and who will get left behind in the crosshairs of new policy?
Elaine M. Stokes, is a Vice President and Portfolio Manager at Loomis, Sayles & Company.

Elaine Stokes is a vice president, portfolio manager and co-head of the full discretion team at Loomis, Sayles & Company. She has 29 years of investment industry experience and joined Loomis Sayles in 1988. Ms. Stokes co-manages a variety of mutual fund and institutional strategies, including the firm's flagship fund. Prior to becoming a portfolio manager in 2000, she had experience working in high yield, global and emerging markets, serving as a senior fixed-income trader and portfolio specialist.

Ms. Stokes is co-head and founder of the Loomis Sayles Women's Network group and is on the executive board for the Strong Women, Strong Girls nonprofit organization. She is a frequent speaker and panelist, featured as a keynote speaker for the Morningstar Conference 2015, CNBC, and WealthTrack.

Ms. Stokes earned a BS from St. Michael's College.

Jens Peers
Jens Peers, CFA®

CIO Sustainable Equities and Fixed Income Mirova1

It’s hard to look at 2017 and not talk about the plans of US President-Elect Donald Trump. With that said, here are my top-of-mind thoughts for sustainable investing in the new year.

Equities may outperform bonds. Tax cuts and infrastructure spending could boost corporate earnings, job growth and consumer spending. We would expect these three factors to support equity market performance. Simultaneously, they also lead to higher inflation expectations. While inflation also typically has a positive impact on equity markets, it pushes nominal interest rates up and bond prices down. In this environment, we would expect equities to outperform bonds.

Green bonds growing in importance. For his infrastructure spending, President-Elect Trump’s plans seem to rely heavily on the private sector for funding, mainly via PPPs (Public-Private Partnerships). As project finance is capital intensive and with banks globally being more careful choosing how they allocate their capital, the bond market could play an increasingly important role. Green bonds’ proceeds are used to finance clearly defined projects with a positive environmental impact: climate change mitigation, water quality, biodiversity, etc. While climate change may not be very high on Trump’s agenda, other areas such as water, efficient electricity transmission and efficient transportation via railroads are certainly part of the infrastructure plans, which could help Green bonds to continue their growth in popularity.

Prudence is warranted. In the aftermath of the US presidential election, cyclical, infrastructure-exposed equities have performed strongly as investors anticipated higher economic growth for longer and increased infrastructure spending. It will take a while, however, before details of this new spending will be known and even longer before companies will see this translated into earnings. There is a risk of disappointment during the next few quarterly earnings expectations.

The importance of thematic thinking. Urbanization, globalization and digitalization are important trends that for many of us have had a huge influence on how we live today. While those trends are expected to continue, for many others in our society, they are happening too fast. The different needs of millennials versus an aging population create further short-term tension on the political and economic front. The recent pull back in tech and health-related stocks may provide a good longer-term investment opportunity, especially in areas related to personalized medicine, treatment of age-related diseases and elderly care.

Utilities the positive surprise? As inflation expectations picked up, long-term interest rates rose during the first few weeks after the US presidential election. As a result, typical bond proxies, such as real estate investment trusts (REITs) and utilities, underperformed the broader equity market. US utilities could be some of the main beneficiaries, however, of what seems to be driving investors these days: corporate tax cuts (as they are typically 100% US exposed), increased infrastructure spending with opportunities in water and electricity transmission (smart grid) and increasing inflation (as water and energy prices are usually inflation-adjusted).
Jens Peers, CFA®, is a CIO Sustainable Equities and Fixed Income at Mirova1.

Jens Peers is CIO Sustainable Equities and Fixed Income of Mirova, a subsidiary of Natixis Asset Management (Natixis AM), engaged in responsible investing. He joined Mirova in 2013. Prior to Natixis AM, Mr. Peers was head of portfolio management – environmental strategies for water, agribusiness and cleantech (renewable energy, energy efficiency and waste management) at Kleinwort Benson Investors, Dublin. He also was a financial analyst at KBC Asset Management and a financial advisor at KBC Bank, Brussels. Mr. Peers began his career in 1998.

Mr. Peers holds a master’s degree in applied economics from the University of Antwerp, Belgium. He also is a CFA® Charterholder and is a certified CEFA (Certified European Financial analyst of the BVFA-ABAF – Belgian Association of Financial Analysts).

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