The single biggest market driver of 2017

“I think the biggest, or the most interesting issue, that's going to evolve in 2017 is going to be the way inflation comes through, the size, the magnitude, and then the market's reaction to it.

Just to be clear, we should see a bottoming of global inflation about the first quarter of next year as energy prices will roll over the basing effect of last year. In the U.S. in particular we've seen the pickup in wage inflation. Even here we clearly have signalled electricity rate rises, the GDP numbers, weak as what they were, indicate that wage growth is starting to emerge again a little bit here. All-in-all it says that inflation is going to go up now. We just need to bear in mind we're not talking about 6% or 7% or runaway inflation. We're talking about inflation going up from 2% to maybe 2.5% or possibly 3%, but that is a significant shift from a lot of discussion about deflation.

In turn, it has repercussions everywhere in terms of the rate environment. In terms of the kind of equities you should have... pricing power equities. There will be other influences but in my opinion this will be a fairly predominate influence throughout the year.

Rates will often try to predict this inflation. Most of these financial market nerds will spend time looking at things like inflationary expectations, and the TIPS market in America, the Treasury Inflation Protected Securities, and try to work up where they can position themselves accordingly. It's quite likely that rates will possibly run a little bit ahead of the inflationary trajectory, so we may well see bond yields rising (bond prices falling), and then giving up a little bit and then retracing. It's probably going to be a patchy move just until there's some conviction that it will come about. It implies rates probably globally will be higher, and possibly higher than expected at the end of next year.

Even here, not withstanding weak GDP numbers, I wouldn't be surprised to see people start talking about a rate rise in the second half of next year compared to some who still believe there's a rate cut that could come through. I'd be very surprised.

I think on the equity markets specifically, the one that I think will be closely watched is whether revenue growth can come through. I think we're done beating ourselves on the chest in terms of cost cutting and restructuring. That can only go that far. Unlike the U.S., we don't have a kitty bag to do buy backs, because companies are not terribly cash flow flush here and the dividend payouts are so high. It's got to be revenue growth. Revenue growth has apparently picked up in the market, but it's been predominately driven by the resource sector at this point. What we'd want to see is some more broadly based revenue improvements coming through as companies find their mojo in terms of how they position themselves in markets, in the way demand really lies rather than sort of gazing around wondering about what monetary policy is going to do for them.

The big risks next year still remain political. In fact, you could argue that probably government risks are probably the ones we're going to spend some years talking about, but European elections are unquestionably the event risk political spectrum of next year. We don't know exactly what the U.S. administration is actually going to truly do once they're in power. I mean it's one thing to say things; it's another to actually execute it through Congress and the House of Reps. As we know even here domestically it's not that sure. We have China's Politburo going under a major change in personnel, so I think it's mostly about political risks as opposed to the past 10 years where we've lived mostly through Central Bank risks. Those are probably going to be a second tier to government-type risks in the coming year.