Where Are The 'Black Swans' Hiding?
While being capable of imagining a ‘black swan’ event implies its non-existence; given the level of groupthink consensus agreement that the bond bull is dead, inflation is back, central banks are maxed out, and global fiscal stimulus will save the world, we thought a look at some of the more unsusual, unpredictable expectations for 2017 was worthwhile…
1. Bond yields to fall?
HSBC, which correctly called the recent slide in U.S. bond yields to historic lows, says bond yields may well rise next year and expects 10-year Treasury yields to hit 2.5 percent.
But only in the first quarter.
After that, HSBC’s bond strategist Steven Major reckons they will fall back to 1.35 percent because 2.5 percent would be unsustainable under tightening financial conditions, dragging on the economy and constraining the Fed. A bold call.
2. U.S. 10-year yield at 4 pct?
“Forget the boring old investment bank research for 2017; find out what the greatest minds of City Index think are the best trading opportunities for the year ahead!” They certainly don’t hold back: Stocks get “slammed” as the end of the bond bull run “starts to bite” and pushes 10-year U.S. Treasury yields to 4 percent; And the oil producers’ agreement to cut output falls apart and crude plunges to $15/barrel.
3. Four Black Swans
Economists at Societe Generale illustrate a graphic with four “black swans” that could darken the market landscape next year. The tail risks they see as most likely to alter next year’s outlook stem from political uncertainty (30 percent risk factor), the steep increases in bond yields (25 percent), a hard landing in China (25 percent), and trade wars (15 percent).
4. The euro also rises
“The dollar is overvalued versus other G10 currencies” is not something you hear too often.
But it’s the view of Swiss wealth management giant UBS, which predicts the euro will end next year at $1.20, drawing support from the ECB tapering QE. Undervalued sterling will rally too, picking itself up from its Brexit mauling.
5. The “good carry” in EM
Few dispute that a higher dollar and U.S. yields next year will hurt emerging markets. Goldman Sachs expects both, but two of its top 2017 trade tips involve buying EM assets.
One is going long on an equally weighted FX basket of Brazilian real, Russian rouble, Indonesian rupiah and South African rand versus short on an equally weighted basket of Korean won and Singapore dollar to earn “the good carry”. The other is going long Brazilian, Indian and Polish equities.
6. $1 trillion U.S. earnings bonanza
How much offshore earnings can U.S. companies bring back if president-elect Donald Trump follows through with his pledge to cut corporate tax?
About $1 trillion, according to estimates by Deutsche Bank. This could give U.S. stocks, already at record highs, another shot in the arm. Citi reckons global equities will rise 10 percent next year, led by developed markets. A 10 percent rise in the dollar and cut in U.S. corporation tax to 20 percent could add 6 percent to global earnings per share.
7. China shop bull returns
Chinese stocks will bounce back into a roaring bull market, predicts Morgan Stanley. It reckons the Shanghai Composite index will end next year up 36 percent at 4,400 points, with EPS growth at 6 pct.
This is predicated on there being no significant U.S.-China trade protectionism conflict, although the threat of one and the relatively early stage of the Chinese recovery will keep domestic monetary conditions loose in the first half of 2017. Tougher property sector rules are also starting to divert wealthy individuals’ capital towards stocks, MS says.
8. Yuan over the eight
Many FX analysts expect the Chinese yuan to continue falling, but few see it breaking on the weak side of 8.00 per dollar. Those at Deutsche Bank do, albeit not until 2018, though that would still mark a sizeable fall next year for a currency tightly controlled by Beijing. A rising dollar is one side of the equation. And on the other, Deutsche reckons Beijing will not want to see reserves fall below $3 trillion, meaning capital outflows will hit the currency harder than the last couple of years when reserves have been used to cushion the yuan’s fall.
Here’s the scenario: Britain stays in the European Union. Goodbye Brexit, hello Bremain. It’s highly unlikely, and analysts at Nomura don’t think it will happen. But it’s one of 10 potential “gray swan” events for next year they reckon investors should at least consider. “As 2016 was the year politics ‘stumped the consensus’, why couldn’t 2017 do the same?”
One possible path to such an outcome would be UK-led, via a general election, perhaps triggered by court proceedings or whether London would need Scottish and Welsh parliaments’ consent. Alternatively, the EU could offer the reforms the UK has been asking for all along, tempting Britain to stay. One related investment idea could be to go long sterling/yen, Nomura says.
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While we would like to be able to predict black swans, by definition they are unpredictable. However, its close cousin, the grey swan, can be envisaged. The scenarios above are the unlikely but impactful events that lie outside the usual base case and risk scenarios of the analyst community.