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2016 will be remembered for both its political and financial milestones as a year that tested the resiliency of investors around the globe. The year started with capital market volatility, but the script has since flipped, and most major market indexes look to end the year in the black.

A crash in oil prices, a global slowdown (including talk of a U.S. recession), currency devaluations, worldwide banking concerns and global central bank policies all captured the attention of investors during the first six weeks of 2016, resulting in an 11 percent fall in the S&P 500. A rebound in oil prices and continued monetary easing by central banks led a turnaround in U.S. equities, helping the S&P 500 finished Q1 up 1.35 percent.

A more than 30-year fixed income bull market continued as central banks kept interest rates at historic lows, and record amounts of sovereign debt traded at negative yields. Global uncertainty lead investors to seek safety, driving yields lower as the total return for the Barclays Global Aggregate index posted a positive 5.90 percent return during the first quarter.

Market volatility hit an apex during the second quarter as Britain voted to exit the European Union. Global markets tumbled immediately following the referendum, costing investors more than $3 trillion in the two days immediately after the vote and the British Pound collapsed to a 31-year low. After the initial shock and concern set in, cooler heads prevailed as swift political change and monetary policies helped calm fears.

Investors’ confidence increased as it became clearer that the Brexit fallout would have a muted immediate impact on the global economy. Improved economic data, along with a continued accommodative monetary policy by the Federal Reserve, lead to a “risk on” environment.

Markets zigged and zagged as one of the most contentious U.S. Presidential elections in more than a century neared. Prior to the election, equity and fixed income markets alike feared the uncertainty of a Trump Presidency. The “Trump Trade” followed as U.S. equity markets hit record highs, while fixed income yields spiked, placing doubt in the longevity of the fixed income bull market.

As 2016 winds down, expectations are high that the Federal Reserve will increase the federal funds rate, which looks to be already priced into the market. Will the “Trump Trade” continue for the remainder of the year, providing a very strong finish to a watershed year? We’ll see.

Figure 1 - Monthly & Quarterly returns for major indexes

Looking ahead to 2017

The resiliency of investors will be challenged again in 2017 as many questions—both political and financial—remain.

The coming year will mark the first time since 2006 when a Republican (George W. Bush) presided over the Oval office while a Republican majority controlled both chambers of Congress. As you can see in figure 2, the market performed positively in 2003 (+28.69%) and 2005 (+4.89%). 

Figure 2 - Calendar Yr. returns during Republican President & Republican controlled Congress

With Republicans controlling both the Senate and House of Representatives, Trump faces fewer obstacles on his path to reducing taxes, increasing infrastructure spending, and reducing regulations which all served as fuel to the recent “Trump Rally.”  Financials look to benefit from rolled back regulations and an increase in interest rates, while a strong dollar and continued protectionist rhetoric will boost small companies who conduct the majority of their business within the borders of the U.S. As Trump’s policies become more clear will this “Trump Rally” continue, or will it turn out to be a “Trump Bubble”?

All good things must come to an end, right? An increase in the federal funds rate, which is in arm’s reach, partnered with the “Great Rotation” is placing downward pressure on bond prices, which is putting the 36-year long fixed income bull market in jeopardy. However, diverging monetary policies around the globe will play a role in if the bull market continues. While yields on U.S. fixed income are on the rise, yields on foreign sovereign debt continue to stay at all-time lows, which will help support U.S. bond prices as foreign investors hunt for yield and flee to safety (see below).

Could 2017 be closing time for the European Union?  Brexit marked the beginning as Britons voted to leave the EU, but 2017 could mark the end as numerous important elections are on the horizon. The headliners are the French Presidential election followed by the German Federal election, which have the potential to be breaking points for the EU. Another “populist” victory will lead to more demand for safe havens such as U.S. Treasuries, the Yen, and gold, while putting downward pressure on Bunds along with European peripheral Italian, Spanish, and Portuguese assets. 

A strengthening U.S. dollar along with an increase in commodity prices can help offset Trump’s protectionist rhetoric risk that emerging markets will face in 2017. The growth in China is predicted to slow down further. However, for now it is not expected to exert a significant drag on global growth prospects while an increase in infrastructure spending on U.S. soil will help boost commodity prices, providing support for emerging market equities.

As we get close to shutting the doors on 2016, which brought us historic events and positive market performance, 2017 looks like another year that could provide some historical moments. Enhanced portfolio diversification will be of utmost importance during this year of uncertainty. 

Michelle Kwek, Head of Content: Singapore & Hong Kong, Informa Global Markets and Christopher Shiells, Senior Emerging Market Analyst, Informa Global Markets contributed to this article.

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