2017 began with significant uncertainty surrounding the implications of the major geopolitical changes that happened during 2016. In the next few weeks, we will learn more from the British Prime Minister on the process to withdraw from the European Union. On January 20th, Donald Trump will be sworn in as the next President of the United States. The impact of these two changes in the global environment will most likely drive the course of markets during the year ahead.
From an economic perspective, the U.S. economy continues to chug along, and the December employment report, despite the headline payroll number being slightly below expectations at 156,000 versus an expected 175,000, confirms that the U.S. economy remains on firm footing. The increase in average hourly earnings (0.4% in December and 2.9% in the past 12 months) will be closely watched to see if pressure on wages drives an uptick in inflation and/or pressure on corporate profit margins.
From a markets perspective, I prefer to be defensive on U.S. bonds, both Treasury and Corporates, due to rising inflationary pressures and the potential impact of protectionism. There are two ideas I like for fixed income securities. The first is being long non-U.S. dollar-denominated bonds versus bonds denominated in U.S. dollars, as I believe the U.S. dollar will weaken during 2017 and reverse the trend seen in 2016. The second idea is buying Treasury Inflation Protection Securities (TIPs) and paying fixed on 30-year interest rate swaps to hedge the interest rate risk. With rising inflation expectations, TIPs stand to benefit and the negative swap spread is a compelling way to manage the interest rate exposure. Of note, swap yield is less than Treasury bond yield
I look to move to a short position on U.S. equities around the time of the inauguration, as the stock market has had a significant move and valuations appear stretched. I don't expect earnings to keep up with expectations in the first half of 2017.
The year ahead has the potential for significant surprises, as the changes currently impacting the environment only occur every few decades. Being nimble and ready to revise strategies and opinions to adjust to market sentiments will be important.
This blog post is for informational use only. The views expressed are those of the author(s), and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Any statements about financial and company performance of The Penn Mutual Life Insurance Company or its insurance subsidiaries (each, “Client”) made by the author is provided with a written consent from the Client. Penn Mutual Asset Management is a wholly owned subsidiary of The Penn Mutual Life Insurance Company.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.
High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
All trademarks are the property of their respective owners. This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission.