Global growth expectations have inflected, with financial markets demonstrating resilience to this year’s two surprises – Brexit and the US presidential election.
Looking back, the Brexit vote changed everything, triggering a sea change in monetary policy guidance and, with it, a rekindling of inflation expectations.
The US president-elect, Donald Trump, strengthened the transition from a deflation-prone world to a more inflationary one, with pledges to reinvigorate the US economy by increasing infrastructure spending and decreasing taxes. Since the elections, inflation expectations have soared, led by the US, but with the move becoming increasingly broad-based across developed economies.
Next year, major economies are likely to benefit from the baton passing from monetary to fiscal policy. Infrastructure in the US is in need of modernisation and an upgrade could have a sizeable economic impact. While economic multipliers are hard to predict, it is worth remembering that employment is at a very high level, which may slightly dampen the effect of fiscal stimulus. Nonetheless, growth is inclined to be supported and moderately above trend in the coming years. The world economy should also benefit.
This backdrop will give the US Federal Reserve the confidence to raise rates further next year. The market is debating the timing and the extent of US rate hikes but the consensus seems to be increasingly confident that global bond yields have bottomed. Other central banks will likely mirror the US approach as they respectively reach the limits of monetary easing.
This regime change favours a switch into equities from fixed income, with a more positive economic background serving as a catalyst for investors to embrace riskier assets. The seismic shift that started in July is not to be underestimated and marks the end of a 35-year relationship investors have had with bonds.
Within equities, the new regime favours value shares over bond-like equities and there has been a spectacular rotation of market leadership during the second half of this year.
The two sectors that have embodied the deflation/reflation divide (safe bond proxies versus deep value) are consumer staples and banks; between which there has been a 27 per cent differential in S&P500 performance since July. Despite this extreme relative performance these trends could well continue into 2017, as earnings growth is picking up around the world justifying why investors can be rewarded for moving up the risk spectrum. In the new world, the dispersion in the market (the gap between winners and losers) is likely to remain elevated.
Amid renewed optimism in the global economy, it is prudent to note that US markets exit this year at levels close to all-time highs, pricing in a sizeable portion of good news, yet political and policy risks abound. Whilst these risks could undoubtedly have big implications for markets, the global economy should continue to grow next year, providing a supportive backdrop for corporate earnings and global financial markets. With central banks continuing to suppress the rewards of holding cash, the low opportunity cost of holding cash means one could see an increasing role for equities.
It is very important to focus on regions that will benefit from the changing mix and display the right balance between earnings growth, dividend yield and multiples.
To this end, select opportunities are now emerging in Europe and Asia, regions that underperformed this year. Of course, not all cyclicals and defensives are created equally and, whatever 2017 brings, active management and a flexible approach will enable investors to identify pockets of value and capitalise on the increased dispersion anticipated in the year ahead.
Grace Peters is executive director and EMEA equity strategist at JP Morgan Private Bank.

Source: The National