Top Three Things on Managers' Minds for 2017 (Part 2)

Is an era of sweeping change about to get under way? With talk of huge policy shifts by the new Trump administration, including global trade, along with key elections taking place in France and Germany, 2017 could be a very interesting year.

Alternative and European Equity managers from across Natixis Investment Managers share their thoughts as they look to navigate global markets in the new year.

Our Panel Responses

Duncan Wilkinson
Duncan Wilkinson, CFA®

Chief Executive Officer AlphaSimplex Group

Rising interest rates. Don't look now, but US Treasury yields actually seem like they are rising.

While things began to change in October, it was the US presidential election on November 8 that really triggered a rather sudden and sharp increase in the US 10-year yield. Is this the bottom for Treasury yields and the beginning of a steady increase in yields? It is too early to tell. However, it is a good example of how a trend can form based on new fundamental information.

If interest rates continue to rise in 2017, long positions in bonds will be challenged, and portfolios that have the ability to go short bonds may have an advantage in such an environment. Investors have benefited from a strong 30-year cyclical decline in interest rates; however, that will probably not be the wind at their backs in 2017 as it has been in recent history, and instead, it could potentially be a strong headwind.

Rising equity risk and volatility. At AlphaSimplex, we have our own measure of downside equity risk called the Downside Risk Index (DRI).* Currently, that measure for global equity risk is elevated, above average, although not at extreme levels for international and emerging market stocks, and about average for US stocks. This may seem counter-intuitive given that stocks have delivered modest gains so far this year and since there was not an extreme negative market reaction to the US election results.

As we look back at 2016, the first quarter was a roller coaster ride for stocks as the world became concerned about the slowdown in China's growth. While almost a year has passed, it is fair to say the health of the Chinese economy continues to be a global risk with a new wildcard, which is the direction of the United States and China trade relations. We also had concerns about the European recovery, complicated in part by the complexity of immigration and a refugee crisis. And let's not forget the Brexit vote, which, similar to the US election, added a pint of uncertainty to the world order.

Volatility of regulatory change. We often talk about the volatility of stocks, and we are typically referring to the standard deviations of returns over some period (e.g., a month, a year). We have a mathematically defined measure of volatility for stocks, which allows us to have a reference, based on hard numbers that we can compare to historical averages to know when volatility is high or low. While we do not have any such measure of the volatility of regulatory change, I think it is fair to say that if we did, it just spiked to extreme levels.

There are a number of regulatory changes that have been implemented during the Obama administration and many that were far along the regulatory pipeline. This includes everything from big financial regulations, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, to broader regulations that have financial impacts, such as the Patient Protection and Affordable Care Act (ObamaCare), to the Securities and Exchange Commission (SEC) proposal on derivatives and the new liquidity rule, as well as Department of Labor rules on fiduciary standards. Will these regulations be repealed and replaced by the Trump administration? Will they just be tweaked a bit? Will some just die a quiet death in the rule-making process? Will one be implemented only to trigger the elimination of two more regulations?

It is too soon to know for certain. However, as the new administration begins to fill open positions, such as SEC commissioners and Treasury Secretary, each new bit of information will lead to speculation – some of which may indicate change, and some of which may signal less change than anticipated. This juxtaposition is something that I think we have learned is part of the Trump style. This speculation back and forth, and the implications on the markets, is what I would define as Regulatory Volatility (or “RegVol”), and I would say it has never been higher.
Duncan Wilkinson, CFA®, is a Chief Executive Officer at AlphaSimplex Group.

As Chief Executive Officer of AlphaSimplex, Duncan B. E. Wilkinson oversees the business activities of the firm and is responsible for its strategic direction. Mr. Wilkinson has served as a member of the AlphaSimplex Board of Directors since 2007 and as a member of the Audit Committee since 2014. Prior to joining AlphaSimplex in 2014, he served as Executive Vice President, Director of US Affiliates for Natixis Investment Managers. Mr. Wilkinson joined Natixis in 2000 and has held the positions of controller, global treasurer, and deputy global chief financial officer with the firm. Prior to joining Natixis, he was a senior manager with PricewaterhouseCoopers LLP focusing on investment management clients.

Mr. Wilkinson holds a BA from Brown University and an MBA from Boston University. He is a CFA® charterholder.

CFA® and Chartered Financial Analyst® are registered trademarks owned by the CFA Institute.

Isaac Chebar
Isaac Chebar

Portfolio Manager DNCA Investments

Will 2017 be the year of all dangers? One might think so after listening to all of the commentary on doomsday scenarios and the malfunction of Europe.

Certainly there are a lot of unknowns today. Elections in two of the main euro-zone economies, France and Germany. Extremist, populist political parties all over the place mocking the euro. Deficits under control but at the cost of high disparities between North and South. Obviously, visibility of the market’s direction is reduced. But when has the equity market ever been 100% clear?

Looking out at the European landscape, a few constructive thoughts come to mind:
  • If there is a place where taxes can be reduced, it’s Europe. Countries with high unemployment rates like Spain, Italy and France might surprise all with a genuine supply-side approach.
  • Infrastructure budgets are being boosted in the developed world and Europe might not want to be left behind.
  • Consumer confidence is still at high levels considering events (terrorist attacks, banking problems in Italy, Deutsche Bank fears, Italy referendum, Brexit). This could be a sign of better things to come.
  • Companies have relentlessly reduced operating costs in Europe. Credit growth earmarked for investment is starting to pick up, thanks to European Central Bank (ECB) liquidity easing and credit availability. A weak euro combined with still very low interest rates may provide a powerful combination under better economic conditions.
Corporations could benefit from the above conditions, as well as a more flexible labor market. Consumer spending will probably lag much of the year, but lower unemployment and some wage growth in early 2018 could be a second kicker in this European "growth revival". Of course, thinking this on the eve of the important Italian referendum (scheduled for December 4) may appear wishful.

Even if Italians vote "No", which would lead to the resignation of Prime Minister Matteo Renzi and weaken the euro cause, things take time and many steps. Everybody feared the election of Donald Trump. But the markets have rallied well (for sure exaggerated as we still need to see his actions). In France, elections are still open through April, but as of yesterday there is a clear right-wing (Les Republicains) candidate, Francois Fillon, with a credible economic plan to face off against and possibly defeat the populist (Front National) candidate Marine Le Pen.

We still have hurdles to pass in Europe. But step by step we might get there. And what about the Brexit? Can it be reversed? This would be a big surprise that could catch us off guard. But, What If….?
Isaac Chebar, is a Portfolio Manager at DNCA Investments.

He focuses on European equities for several DNCA portfolios. Isaac joined DNCA's management team in 2007. Prior to that, he was head of European investments managing discretionary funds at Aviva Asset Management. In 2000, he joined Tocqueville Finance where he managed its value Europe strategy. Isaac began his career at Société Générale managing funds investing in emerging markets and Southern Europe. He holds a chemical engineering degree from the Polytechnic School of The University of Sao Paolo, in Brazil.