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Equities remain Robeco’s preferred asset class for 2017, offering new opportunities but also risks as ‘Plan B’ is rolled out in the Trump era, says Lukas Daalder.
Addressing the Robeco Live conference in Rotterdam, he warned that government bonds face rising yields – which means falling values – in 2017, with a growing disconnect between US and European sovereign debt.
But he remains optimistic about the prospects for global growth, as the world gradually moves from the ‘Plan A’ of relying on central bank-led monetary stimulus, which has not had the desired effect and has led to greater populism, to the new ‘Plan B’ of using fiscal stimulus such as higher government spending on infrastructure instead.
“Equities are still the most promising asset class for 2017, but it comes with a huge disclaimer – Trump,” says Daalder, Chief Investment Officer of Robeco Investment Solutions, and a co-author of the 2017 Outlook.
“If Trump behaves and doesn’t do anything rash, then this should be an OK year for equities, but he’s the biggest uncertainty facing the markets. We’re all waiting for the details of his plans, and a lot will depend on what he actually does. But we remain moderately optimistic about growth, and our key theme is that it’s time to move from Plan A to Plan B, where fiscal stimulus eventually replaces monetary easing.”
Daalder uses the analogy of trying to change the course of a vast state-owned ship that has so far been powered by quantitative easing and rate cuts, in mostly unsuccessful efforts to stimulate economies, and now needs to be sent in the other direction.
“If you look at economies, they are generally subject to self-enforcing trends, where if the trend is down, it will continue to do that for some time,” he says. “It’s like trying to turn around an oil tanker. People have expectations, and if these are not being met, they won’t invest, hire workers or build new factories. So growth doesn’t reach the level that is needed; so more people get fired, more investments get scaled back, and it becomes a self-fulfilling prophecy.”
“But the same is true on the upside: when people expect better times ahead, they invest in new factories and hire more people. For five years we’ve basically been in this downtrend, so we need to find out what can turn this ship around. ‘Plan A’ was to do it with monetary stimulus, but it hasn’t worked, so ‘Plan B’ would be some sort of fiscal stimulus.”
“Governments could start spending and building things, but that’s not going to be the whole story. We don’t want governments to take all the burden, but we need someone to be the spark that makes the oil tanker move in the opposite direction, and then you have a sustainable recovery.”
“So ‘Plan B’ is essentially whether governments take on this role, and with Trump, everyone seems to think that they will, and that it might work. They think that Trump will lower taxes and build new infrastructure, but in Europe the outlook is a lot less clear because there are budgetary rules for spending, keeping deficits to within 3% of GDP.”
“Here, some countries have room for higher spending, such as Germany, and others don’t. So it’s less clear where such a turnaround can come from unless you get different governments and a shift in power as we saw in the US. That’s more an issue for 2018 than 2017.”
Daalder says Europe’s biggest risk this year is the national elections in three of its largest economies: the Netherlands, France and Germany. All three countries have significant populist movements that have the potential to follow the anti-EU stance seen in the Brexit in the UK last June.
The Dutch will set the ball rolling on 15 March, with populist leader Geert Wilders looking to build on the Brexit sentiment in the parliamentary election. French Presidential elections, in which far-right leader Marine le Pen is a candidate, occur in two stages on 23 April and 7 May. German federal elections – which could see Angela Merkel unseated as Chancellor – are due to be held between August and October (see chart).
“The elections in Europe, and whether we going to see a further rise of populism, are a major risk factor in Europe,” he warns. “In the Netherlands, the odds of Geert Wilders becoming prime minister and going for some sort of EU exit is small; the real risk is Marine Le Pen becoming President of France.”
“So the outlook is mixed for Europe. But in general, we can clearly see higher US growth, while at the same time warning that Trump has increased uncertainty economically as well as on financial markets. The equity market seems to have embraced him, but the odds of unwanted outcomes have clearly increased.”
That lack of clarity on Europe and the potential for adverse outcomes for investors is reflected in the government bond market, Daalder says.
“For bonds, our message is more outspoken for the US than it is in Europe,” he says. “In the US we expect bonds to suffer, in the sense that yields will go higher, combined with higher inflation and debt caused by the planned stimulus by Trump. The Fed is also hiking rates, so there’s a clear story here that yields will rise. It’s never a one-way street, but the trend of ever-lower yields has been broken in the US.”
“The picture for Europe is lot less clear because normally the Continent follows what happens in the US. Since Trump’s election, Europe has only partially followed, and the bond spread differential between US Treasuries and German Bunds is now at the highest level for 30 years. That’s all to do with the European Central Bank (ECB) being an active buyer and therefore limiting the negative spillover on yields from the US.”