Assuming President-elect Donald Trump’s proposed fiscal spending plans go ahead and remain a priority, US and global growth is likely to benefit, lifting demand for raw materials.
Commodity prices to rise?
Historically, stronger commodities demand tends to lead inflation – so if there is to be any substance in the ‘reflation trade’ which has recently gripped markets, we need to see commodities rise. OPEC have recently sent oil prices soaring back above $50 per barrel, yet if Trump is to flood the markets with shale gas then we could expect the upside to remain limited. As to whether this will be a headwind in 2017 or 2018 is down to the selection, speed and order of Trump’s deregulation promises.
To counter this, OPEC are likely to cut production further to help support prices. If Trump no longer requires oil imports from Saudi Arabia, for example, this will either spur further production cuts or new trade agreements across the Middle East. Either way, it appears OPEC can support any headwinds that a potential shale gas boom may inflict.
Technically the rally from the lows has not even hit 38.2%, which lands around $61 per barrel. Whilst we see upside and a $60 per barrel as likely, we also note that price action in H2 2016 does not appear as impulsive as you’d expect if we had just witnessed a multi-year low. Therefore, we remain cautiously bullish throughout 2017, and allow plenty of room for whipsaws as the oil production and shale gas industry stories play out.
More Upside for US Stocks in 2017
Trump policies aside, leading indicators have been pointing towards a stronger economic recovery in 2017, which would be net-supportive for stock markets. These expectations have only improved since Trump was elected, which has helped US stocks break to record highs. Whilst interest rates remain historically low, the next few hikes are unlikely to weigh on their advance so risks remain to the upside.
However, if inflation runs out of control and the Fed react with a more aggressive path (as the Fed’s Jeffrey Lacker has warned it will do) then we could see hiring slow down, lower new orders, production and output, and resurgent whispers of a recession. Stocks, which are forward-looking by their very nature, would have already sold off before these outcomes were ever concerned, like we saw in Q1 2016.
European equities have faced headwinds due to ongoing political uncertainty, notably the banking crisis, Greek debt, and of course Brexit. If it were not for these factors, stocks would likely be trading far higher as economic indicators point towards a mild recovery in 2017.
We expect headwinds to remain as long as uncertainty prevails. If we find, for example, that Europe doesn’t copy the US with anti-establishment voting and that the banking crisis could be fixed than this leaves relatively higher upside potential for their stock markets.
European vs US equities
As things stand, US stocks appear likely to outperform European stocks next year. It is a relatively safe bet at present as US equities have outperformed since 2008, and relative conditions going into 2017 favour this trend to continue.
Technically, the ratio line (lower chart) remains bullish. Whilst it has tested the upper boundary it doesn’t necessarily mean it is due to a pullback as it could just as easily creep up the inside. We see this as the more likely course in H1 2017. However, if we are to take the alternative view that the political uncertainty in Europe will subside, European economic data will pick up and Trump’s policy promises will backfire, then we could envisage a scenario where the ratio flips quickly changes and European stocks outperform US stocks in H2 2017. Of course, until some of this political uncertainty is removed then the bias if for US to outperform Europe.
Matt Simpson is a Senior Market Analyst at ThinkMarkets.com