World Market & Economic Outlook December 2016

World Economic and Market Outlook – December 2016 Graham O’Neill - Director at Independent Research Consultancy Ltd

OVERVIEW •2016 has turned out to be a febrile year for markets & investors •Government bond markets started a trend to higher yields driving sector rotation in equities •This year has been a macro managers market not a stock pickers’ one •Republicans control both Presidency & Houses of Congress •Markets believe in a pro-business agenda but Trump watchers still need to focus on 3Ps •Fed has more optimistic on US economy with rate rise expectations for 2017 increasing •US currency has strengthened significantly post the election •Geopolitics to become much more significant for markets in 2017 •More hawkish Fed policy & stronger US$ calls for short term caution on Asia & EM •China post latest stimulus package seen economy rebound & consumer confidence improve •Indian growth hit by demonetisation of high worth banknotes •OPEC cuts have steadied oil price & commodities in general have found a floor •In bond markets non-fixed rate options like FRNs likely to fare best •Macro environment is in transition with wide range of possible outcomes •Prudent investors will look to navigate this with a balanced pragmatic approach •While 2016 is ending on a positive note next year is unlikely to be completely smooth ride

INTRODUCTION As 2016 draws to an end, investors can ponder what has turned out to be febrile year for markets. In January and February, markets sold off on recession fears with some commentators describing the December Fed rate rise of 2015 as one of the worst policy mistakes ever by a central bank. There were also concerns about a rapid and uncontrolled devaluation of the Chinese currency. Markets stabilised and rallied, only then to be hit by Brexit and emergency measures by the Bank of England cutting interest rates to 0.25% and QE. No sooner had investors come to terms with what seemed a lower for longer interest rate world, market sentiment turned on the belief that with the ineffectiveness of extreme monetary policy becoming ever more apparent, the authorities and governments would turn to a fiscal response to try and boost the anaemic post-GFC growth rate.

Government bond markets started their turn in late summer-early September and this quickly led to sector rotation in equity markets. Many parts of the equity market had benefitted from ever lower bond yields, whilst other sectors had been hamstrung by this, especially in the 1

financials space. Zero bond yields were not a good environment for the business models of either banks or insurance companies. This gradual change in market sentiment then suffered shock and awe treatment with the unexpected election of Trump as the US President, which proved the catalyst for a rapid re-pricing of bonds and violent equity market sector rotation with a dramatic change in market leadership. Far from being a stockpickers year, 2016 has proven to be one where macro managers making the correct top down calls have been the ones to add most value.

TRUMP The election of Donald Trump as US President was a surprise to many, but even his most ardent supporters must be taken aback by the markets’ positive reaction, a completely non-consensus view. With the Republicans not only holding the presidency, but also control of both Houses of Congress, markets have been reassured in the belief that a pro-business agenda in the States will be forthcoming. At this stage markets believe that policies will be put in place that promote growth without protectionism. With the new president not due to be inaugurated until January 20​th​, it is far too early to be certain about the policy programme of the next administration.

The market move away from government bonds and also bond substitutes in favour of more economically sensitive areas is understandable, as fiscal expansion will be one of the more easily implemented pieces of Trump policy. As well as an upward move in bonds, there has at last been a pickup in longer term inflation rates, looking at the five-year five-year forward number. This has occurred globally, not just in the States. The US currency has also been strong, and whilst welcomed no doubt by areas such as Europe and Japan, has been problematic for some emerging markets where liquidity conditions have tightened. The sell-off in emerging market currencies that has occurred since the Trump victory has been driven more by this, than fears as yet of a protectionist threat or the imposition of tariffs.

In an earlier piece, we had suggested that Trump watchers need to follow the 3Ps. The first was policy and whether he will follow through on the pre-election rhetoric or tone it down. The second was people and whether appointees would be high quality or yes men. To date the economic appointments look sensible, although there has been a proliferation of populist anti-establishment billionaires to cabinet roles. However, the appointees do look like they understand the needs of business. Appointments on the security and foreign policy front have been more hard line and recent tensions with China suggest geopolitics will become more lively in 2017 than under the Obama administration. Looking for example at the new national security advisor Michael Flynn, someone who quickly gained notoriety during the Republican convention in July leading the calls for the jailing of Democratic contender Hillary Clinton, is a case in point. On the third question, of personality, the jury is still out and whether an egotistical president emerges remains to be seen.

Economic uncertainty will continue until policy details are not only announced, but it becomes clear which ones Congress will approve. Foreign relations also face a period of uncertainty. Trump has promised to dismantle the Iranian deal, but has also been critical of Saudi Arabia. Trump has chosen a hardliner as ambassador to Israel, Mr. Friedman, who has shown a lack of support for a two-state solution to the Israeli-Palestinian problem. In regard to oil and other natural resources, Trump has in his pre-election campaign stressed he is keen to expand domestic production as much as possible.

2

Trump also faces the dilemma of the need to satisfy his core supporters, many of whom have never previously voted Republican. Many Trump supporters in poorer states such as Virginia remain dependent on government largesse in terms of some form of social welfare in a state where the average wage is a mere $13,000. Trump will need to satisfy popular support whilst also keeping the conservative and traditional pro-business elements of the Republican Party in Congress onside.

THE FED With the prospects for a more pro-growth agenda in 2017, attention then focussed on the upcoming Fed meeting in December. Markets quickly priced in an interest rate rise at that meeting, but more importantly focussed on the future guidance on interest rates. The Fed ‘Dot Plot Chart’ post the meeting showed expectations for three rate rises next year, a more aggressive line on tightening than had been priced into the markets for 2017. One important point to note is that the expectations of the Fed on interest rates have not moved up to reflect the growth levels targeted by Trump and his supporters of 3.5-4% real GDP growth. Thus if the new administration is successful in quickly lifting the US growth rate, monetary tightening may prove more aggressive than outlined by the Fed at their recent meeting.

Comments by Fed chairperson, Janet Yellen, suggested that the American central bank had become more optimistic on the US economy, which was seeing a tightening of labour conditions and pickup in inflation even without the proposed infrastructure spend by Trump.

Whilst one or two Fed officials seemed to have made allowance for the new Trump policies, the majority did not as yet.

The immediate market reaction to the Fed meeting was to mark equities higher and bonds lower. The mood in the markets is that growth will pick up and whilst there will be a moderate increase in inflation, it will not be enough to force interest rates markedly higher than current market expectations. Thus rates would not return to pre-GFC normal levels.

Many investors believe that as far as monetary policy is concerned together with economic growth, the Pimco ‘new normal’ environment of secular low growth and low inflation will remain in place. Equity bulls do not believe that the negative Trump policies on trade or immigration will actually be enacted. The best course for markets would be a pickup in the rate of economic expansion but with secular influences containing inflation. If growth improves and monetary policy, even if tightening modestly, remains accommodative by past standards, markets can continue to look through high valuations and make further although in all likelihood limited progress.

TYPE OF CYCLE When interest rates have risen at the start of more normal economic cycles, equity markets have tended to ignore the first few moves. The caveat to this is that the PE ratio at the start of previous tightening cycles has been markedly lower and the profit cycle much less mature.

In fact, in the early months of the year, many investors were questioning whether the bull market would end in 2016 as the economic cycle appeared to some to be running out of steam. American corporates had suffered a profits recession in sectors such as banking, energy and industrials for a couple of years, but even prior to the Trump victory, consensus estimates were for a re-acceleration of corporate earnings in 2017. The US currency has strengthened markedly post the election and a strong dollar will negatively impact on certain 3

sectors of the US stock market, due to the high content of overseas earnings in the profits of the larger listed companies. In contrast to the States, a strong US currency should be positive for profits in both Japan and Europe where the cycle is less mature.

GEOPOLITICS Geopolitics remains a wild card and Trump’s unpredictability came to the fore when he accepted a phone call from the pro-independence Taiwanese president – red rag to a bull in the case of China. Since 1992, the pretence of a One China Policy has kept tensions with Taiwan off the agenda and a policy by the leadership of both China and the States to call the other’s bluff could prove dangerous.

Events in Hong Kong show the danger of pushing the Chinese too hard, where the decision by the SAR’s (Special Administrative Region) Chief Executive, CY Leung, not to seek a second term demonstrates that those who try to push Beijing across its own red lines do so at their peril. The Chinese government had agreed to a plan for Hong Kong’s Chief Executive to be popularly elected in 2017, although insisting the final candidates first be approved by the pro-Beijing dominated election committee. The rejection of this landmark reform by pro-democracy legislators presented Beijing with an ultimatum. The end result of the pro-democracy movement in Hong Kong has been for the proposed reform to die, meaning that the Chief Executive’s successor will be chosen by the election committee as well.

Donald Trump would be foolish to believe that he can succeed where Hong Kong’s democrats did not, by forcing Beijing to cross a red line it has said it will never cross.

Recovering Taiwan is an important priority for the Chinese Communist Party and the Chinese leadership will never abandon the One China Policy. Trump’s lack of diplomatic experience and failure to understand cultural differences has resulted in a situation where he is looking for the Chinese to lose face, something totally unacceptable in Asian culture.

Many geopolitical commentators believe the number one global threat is North Korea. The leader of that country has already used chemical weapons on his own people. He is now trying to develop nuclear ballistic missiles which can be used against another continent such as the United States. North Korea already has missiles capable of hitting the States, but at the moment these cannot be fitted with nuclear warheads. Recently, the UN has imposed further sanctions on that country with the blocking of coal sales, a move only possible because China did not veto this decision. Deteriorating relations with China could heighten tensions in the Korean peninsula and make regional agreement on pre-emptive strikes on North Korea impossible to achieve.

Europe also faces a number of political headwinds in 2017 with elections in both France and Germany. In the Middle East, Iran also has a presidential election in May and the hardliners will be trying to retake control, with any attempt by Trump to roll back on the nuclear agreement likely to undermine President Hassan Rouhani and his moderate followers. The Shia-Sunni war will continue for many years to come, highlighting the regional power struggle between Iran and Saudi Arabia. Saudi’s suffering from the lower oil price are now relying on Vision 2030 to re-calibrate the economy away from its overreliance on oil production. The challenge in Saudi is to provide jobs for non-skilled nationals, who may turn to Jihad if their living standards are eroded due to austerity and the re-balancing of that economy.

4

POPULISM vs CONSERVATISM One potential conflict for Trump will be trying to balance his populism with the conservative Republican wishes in the House of Representatives. Trump is likely to keep traditional Republicans onside by the destruction of Obamacare, right-wing Supreme Court nominees, the appointment of monetary hawks to the Federal Reserve and tax reform.

FOCUS ON ASIA Domestic Liquidity Prior to the Trump victory stock markets and economies in Asia had recovered from the setbacks suffered in the post-taper tantrum period which started in May 2013. Many countries had taken self-help measures to improve economic fundamentals, with as a result monetary easing cycles in place. Even though US interest rates were expected to rise, the dovish rhetoric from Fed chairperson Janet Yellen and the lack of follow-through on the December 2015 rate rise, led to the belief that US monetary tightening would remain gradualist.

The election of Trump proved to be a catalyst for a much stronger US currency and his criticism of the Fed’s easy monetary policy resulted in Asian markets suffering over fears of more aggressive policy tightening in the States. A strong US currency is always a significant headwind for both Asian economies and their stock markets. Whilst there has been headline news about the weakening of the Chinese RMB post the election, China has moved away from a soft dollar peg to a basket approach where the RMB is actually trading stronger than pre the election. Both the Euro and Yen which have weakened significantly post the Trump victory are members of the currency basket the Chinese authorities monitor. The strong US dollar has been less of a headwind to North Asian markets such as China and Korea than the ASEAN region, where for example Indonesia had appeared set for a prolonged period of monetary easing.

China A number of fund management groups who have visited China recently stated at company meetings it is apparent that things have stabilised on the ground. Chinese company management are now more positive and the wider population is gaining confidence to spend again. Retail sales, although slowing from the +12% year on year levels that had been recorded, are still expanding in double digits with the latest number showing year on year growth of 10.8%. The consumer in China seems stronger than his Western counterparts in either the States or Europe. After the missteps in policy in 2015, the leadership in China have recognised the role of the market and now appear less willing to intervene and happier to work more as a referee and policeman. Thus the policy framework in China appears to be more stable. Whilst the progress of reform is slow, the government has closed some inefficient and polluting coal mines and steel producers. China is not a free market capitalist economy and policy measures which would lead to mass unemployment and social unrest are never likely to be enacted. Favourite industries within China include technology, services and also micro businesses which have received tax benefits.

5

The authorities in China will continue to try and force closure of certain traditional segments of the economy but at a gradualist pace. There remain environmental issues in the northeast of the country, where local governments have been closing down some businesses in response to continued problems with pollution. Corporates have seen a stabilisation in earnings in the first half of the year, with carry through and further improvement in the third quarter. Economic data in China appears to be on an improving trend with for example, the PPI numbers indicating an end to deflationary pressures which have hampered corporate profitability. With real disposable incomes growing, the China consumer story remains intact although competition in the country remains fierce with e-commerce providing Chinese consumers with their ‘discount store’ alternatives. There is evidence in China that people are now once again more ready to spend rather than save and are also buying upgraded products which are not always readily recognisable in the economic data. Chinese consumers are now more focussed on quality.

Recent trade numbers have surprised on the upside helped by the depreciation of the RMB and better corporate orders. Leisure and travel continue to increase also aided by continued strong wage growth in the country. Even at a time when corporate profitability was under pressure, the government in China has been keen to create a more even society and expect the rich to help out. Minimum wages in China continue to grow and within state-owned enterprises, the top earners have seen wage caps, in contrast to the pay rises given to lower income people. While some investors have been disappointed by the slow reform in state owned enterprises, this may change for the better post the 2017 Party Congress. President Xi has spent his first term consolidating power and will be better placed to enact reform in the second phase of his presidency.

The level of debt in China remains a concern to many and is more of an issue at the corporate level than the personal level today. The government has undertaken two rounds of debt swaps with local authorities and the central government itself remains under geared. The better investment houses monitor the corporate sector carefully to ensure companies invested in do not hold a foreign exchange mismatch on their balance sheets. M2 growth in China remains strong and this abundant liquidity is one of the reasons why the property markets, especially in Tier One cities, have been so strong. The leading banks, which are all SOEs, will be able to facilitate debt to equity swaps with corporates to reduce the level of gearing.

Banks are likely to become shareholders in certain state-owned enterprises. Whilst debt levels at local government level can look high, investors often forget that both local authorities and the central government have two sides to their balance sheets, with not only liabilities but also assets in the form of equity stakes in corporates. Whilst many SOEs remain poorly run, not only is there scope for improvement, but some state-owned enterprises are making decent returns for their owners.

ASEAN Region Within the ASEAN region, Indonesia remains an economy which is domestically driven and actually doesn’t have a large export sector with the exception of commodities. This year’s strong rally in commodity prices has been a positive, which is why the Indonesian currency is still up against the US$ year to date despite the setback that has occurred in November.

However, further US currency strength if it occurred would put pressure on the Indonesian bond market which often leads that country’s domestic equities.

6

The Indonesian government has successfully enacted a number of reform measures in the last 12 months including a tax amnesty, which not only will bring in flows to the country by the end of the year, but will also widen the tax net. The main exports of Indonesia are coal, oil and palm oil, the prices of which have all risen over the last few months. Thus the trade balance and current account are in much better shape than during the 2013 taper tantrum.

With this improving background, earnings growth in the market should be better in 2017 than 2016 unless the US currency appreciates significantly from here.

Thailand is another ASEAN country which has also been in the news post the passing of the King in October. That month saw volatility due to this factor, but the market has actually been relatively flat in November as investors have focussed on the prospects for a pickup in economic activity in 2017. The military government has been putting in place infrastructure works that should benefit growth next year and the agricultural sector in the southern part of the country is also buoyant aided by strong rubber prices.

The smaller ASEAN market of the Philippines has had a more challenging time, as it was highly rated and over-owned by investors at the time of the election of populist President Duterte. Whilst the markets were originally relaxed about what looked like the election of a pro-business candidate, his anti-Western and anti-American rhetoric has now frightened some investors. Corporates have started to put business expansion plans on hold and there have been fears about the Philippines economy as it has benefitted from significant back office outsourcing by US corporates. The market however has already suffered a significant correction trading on 16x from its 20x peak.

Smaller ASEAN countries such as Malaysia and Singapore continue to face challenges.

Malaysia’s attempts to discourage FX outflows post the Trump victory has backfired and the 1MBD corruption issue has not gone away either. Singapore has continued to suffer from a weak global trade environment and continued problems in the oil service sector as oil majors continue to reduce capital expenditure.

The ASEAN markets had led gains in Asia for much of the year until the election of Trump.

The concern for these smaller South-East Asian countries now is that tightening monetary policy in the States will have knock-on effects in liquidity in their own domestic economy, hitting both the stock market and real economic activity. The future path of the dollar is of vital importance to Asia and the ASEAN region in particular.

India On the same day as the US Presidential election, India announced its own seismic shock with a radical macroeconomic experiment when the country’s two largest currency bills, which account for over 80% of legal tender, were declared invalid in 50 days time. Thus, Prime Minister Modi decommissioned 86% of India’s currency supply in an economy where 90% of transactions are in cash. The argument in favour of this was the fight against corruption and tax evasion, as well as to quell the use of counterfeit notes, often used to finance terrorist activities. One of the problems post the news was that the Reserve Bank of India had not printed nearly enough notes to replace the old ones. Commerce in the country has been crippled, especially in the SME sectors, as wages and suppliers are typically paid in cash and where many people, especially in rural areas, do not have access to electronic payments.

7

India’s demonetisation will knock 1% - 2% off growth in the short term. Unfortunately, it may well be those with lower incomes that suffer most. The hope is that demonetisation only has a short term effect on the economy and that by the second quarter of next year growth once again picks up. In the short term risks remain that the lack of cash in the economy slows down the transactions systems to such an extent that bad debts have a knock on and damaging longer term effect on growth.

Other Emerging In other parts of the emerging world, Latin America had benefitted from the rebound in commodity prices, with Brazil a strong performer in 2016 to date after the impeachment of President Rousseff, whose statist policies had damaged corporate profitability. Whilst the economy in Brazil remains in recession, there is hope that the worst is now past and a new leg of economy recovery can begin. The Trump election has impacted negatively on Latin American currencies and stock markets, with Mexico in particular hard hit after the hard line comments by Trump during the election campaign. The Brazilian Real too has suffered along with the Mexican Peso.

In Russia, there have been signs of economic stabilisation after the strengthening in the oil price and there are now hopes of a more relaxed period of foreign relations with the United States. The pressure on the country from sanctions may therefore ease. For Eastern European countries, the continued recovery in the Western European economies has been a positive.

OIL The consent of Russia and other non-OPEC oil producers to production cuts of 558,000 barrels a day to support the OPEC members’ agreement to cut 1.2m barrels a day has been viewed as a decisive move by the oil market. The cuts by Russia are not quite as generous as first appears, as Russian oil production was already forecast to fall off by a similar amount next year as certain fields came towards the end of their productive life. Furthermore some countries such as Libya, Nigeria and Venezuela are looking to increase production. Both Iraq and Iran have a reputation for cheating on cutbacks and with the Trump administration threatening to unwind the recent nuclear deal the Iranians may be tempted to pump like mad whilst they can!

The agreement does signify Saudi has abandoned its shale focussed strategy and reverted back to defending the oil price. For 2017 as forecastable or not as these things are, oil may trade on average at $45-$65 with the market consensus currently at $55 for the year ahead.

FIXED INTEREST MARKETS Fixed interest markets have had to contend with rising inflationary expectations and the prospect of more aggressive US monetary tightening. Even a rise in US short term rates to 2% would only see real interest rates at zero with inflation at the 2% level. With investors having grown accustomed to many years of falling bond yields and disinflationary pressures, estimates for fair value in core government ten year yields vary considerably. Traditional old school thinking would suggest ten year yields should be around nominal GDP levels, which suggest there could be further price weakness in government bonds over the next 12 months.

Whilst secular forces suppressing inflation, such as demographics and the post-GFC debt 8

overhang remain in place, there are cyclical pressures pushing inflation higher, such as the rise in the oil price from Q1 lows. Estimates for when the oversupply situation in oil comes to an end remain sharply divided. Furthermore, there are signs in certain economies, including the States that wage inflation is picking up as labour markets continue to tighten. On balance, further weakness in government bonds with higher yields seem likely over the course of 2017 although periods of consolidation after the recent upward sharp moves are always possible.

In relative terms, corporate credit remains attractive. Investment grade spreads seem attractive when looking at the likely rate of defaults. A similar argument can also be made about high yield. High yield debt has always shown a stronger correlation to equities than government bonds and therefore the improved growth outlook is a positive for this asset class.

Certain niche funds such as those offering floating rate note exposure could be some of the best performers amongst bond funds over the next six months. The bulls of fixed interest see powerful negative secular forces restraining the impact of any pro-growth Trump policies, but whilst this may be true in the medium term, cyclical factors look likely to make 2017 challenging for conventional fixed interest in 2017.

SUMMARY It is clear that the macro environment is in transition and we would argue this move actually started in September, with Trump proving to be the catalyst which accelerated the speed of change. This has driven not just the fixed interest markets but sector leadership in equities.

Whilst the central case is for higher levels of growth, uncertainties on both policies and geopolitics from a President known for his unpredictability, mean it could be argued that the tail risks of either higher or lower growth have increased. Investors cannot yet be certain what Trump policies will emerge, what reaction will come from the Fed to higher growth and higher inflation and how China will react to a more assertive United States.

This should result in increasing attention paid to economic and market fundamentals, rather than the distortions caused by QE and zero interest rate policies. With markets already highly rated, 2017 is likely to see some bumps along the way at least. The Brexit vote demonstrated the disillusion amongst the wider population for globalisation and investors now need to focus on what levels of protectionism are likely to come to fruition. Whilst globalisation was favourable to a lower for longer interest rate environment, de-globalisation is unlikely to be so. Next year could also see further concerns over the Chinese currency regime’s transition from a US$ peg to a managed basket and whether a decline in the currency will both be orderly and avoid American charges of currency manipulation which could significantly heighten global trade tensions.

In the short term, markets are likely to continue to focus on prospects for higher levels of growth next year. Seasonally, this is usually a positive time for equity market strength and cyclicals in particular often perform well in the December/January periods. Thus in the short term it is hard to see what is likely to break the market’s positive mood, although the catalyst for most market setbacks is rarely readily apparent. If it is to be a geopolitical event which causes that market shock, investors need to remember that Trump will not actually be 9

inaugurated as President until January 20​th​. On the economic front, it will not be clear for a while after this how policies that rely on Congressional approval will pan out. Investors will need to ask whether the global economy is really responding to the increased level of fiscal stimulus and in a way which does not cause a marked pickup in inflation and therefore an end to the accommodative monetary policies that have supported high equity market valuations.

In this environment, investors need to adopt a patient and pragmatic approach and not be swayed by market noise. Valuation is always the best form of risk control and in most markets this is not on investors’ side over the medium term. High valuations themselves are not a cause for many market setbacks, but do mean if bad news emerges, markets can gap down quite precipitously before significant buyers emerge.

Whilst significantly higher interest rates and bond yields would adversely affect equity market valuations through a higher discount rate, fund flows for equities may well remain supportive in the short term as even after the recent setback, bonds appear expensively valued by longer term measures. Some exposure to ‘non-fixed’ interest such as floating rate note products may serve investors relatively well over 2017. Strategic bond funds with a record of successfully managing duration exposure should also deliver above average returns, in an environment where core government bond markets may actually deliver losses to investors over a 12 month period.

At a time of high valuations and market uncertainty, alternatives might appear as a panacea to investor needs, but the returns from the sector in 2016 show that conditions for many absolute return strategies are challenging. This does not mean that positive returns cannot be generated, but some funds in say the multi-asset category reliant on a certain degree of market beta, could find 2017 as challenging as 2016 has been. This is an area where manager selection is vital, as products with little or no market beta are entirely dependent on manager skill to generate a positive return ahead of fees. Well managed equity long-short strategies if they can be correctly identified may continue to be some of the sector’s better performers over the next 12 months as they have been this year.

The fourth quarter has seen a period of severe market rotation favouring equities over bonds and sector leadership change dramatically. Those parts of the markets that have performed especially well in the post-financial crisis period have now gone into reverse, with a move by investors to more cyclical pro-growth assets which looked both under-owned and under-priced relative to their safer counterparts. One of the unusual aspects of the current bull market is that it is defensive sectors that have led returns. Severe price moves have already occurred, so investors now need to ask whether the new trend will be sustained or if it is too late to jump into. Markets have priced in the new US administration’s pro-growth policies without looking at potential downsides from trade protectionism or geopolitical tensions. Furthermore, the US profit cycle is already well extended and the current US bull market is one of the longest running in post-war periods. It looks increasingly likely that for the States at least, a return to a more normal economic cycle which ends through monetary tightening will occur.

As a result, for patient investors, some level of caution seems justified as valuations which were already high prior to the US election have seen long term value deteriorate further.

Markets are now highly dependent on a significant improvement in corporate earnings for 10

2017 and whilst consensus numbers suggest this is possible, bottom-up analyst forecasts are often trimmed back as the year progresses. Whilst the highly rated parts of the market have suffered a sharp setback, the severe underperformance of cyclicals and financials that has occurred post the financial crisis is a long way from being reversed. A balanced approach between growth and value and cyclical and non-cyclical elements of the market will be a pragmatic way for investors to position portfolios. Given the range of possible outcomes investors will need to be prepared to change tack abruptly if surprises occur.

Whilst conventional fixed interest assets look expensive, especially if the optimistic growth forecasts come to fruition, investors should not abandon the goal of diversification and strategic type bond funds or niche products holding FRNs, may be the best way to achieve this whilst reducing the prospect of serious losses if growth accelerates dramatically.

Absolute return funds continue to have a place in investor portfolios, but careful manager selection is vital. Whilst 2016 has ended on a positive note for equity investors, a completely smooth ride for next year appears unlikely.

11