INTERVIEW BRIEFING

03.01.17 ISSUE 98

W H AT Y O U N E E D T O K N O W R I G H T N O W !

0207 290 1271

The information, news and data provided below highlight the key macro economic and corporate events currently affecting
global markets. You should ensure that you are familiar with these issues in order to demonstrate your market knowledge
and interest.

The Christmas and New Year period is always very quiet in markets, with very few company announcements
and little in the way of economic data so I thought that it might be useful to summarise what has happened
in the major asset classes in 2016 and why they have behaved in the way they have.
This could be a typical way for an interview to start at this time of year, there are plenty of questions here!

EQUITIES:

All asset classes have had a volatile year, equities included, although to a varying degree with the FTSE100 and the major US indices hitting fresh
highs whereas the major European markets didn't perform as well.
2016 started very badly for equities, fears of a China slowdown, negative interest rates and the end of QE in the US all added to negative
sentiment, market lows were hit in mid February.
Sentiment began to improve for equities, Chinese data proved more resilient than expected, ultra-low government and corporate bond yields
made equities more attractive to investors.
For the first time in many years we saw divergent monetary policy between the US and Europe, the Federal Reserve started to raise interest
rates as the ECB began to cut them into negative territory.
However, the US rate hike cycle proved to be much slower than most economists and the Fed had anticipated, after the Feds first move there
were expectations of 4 quarter point increases in 2016, there proved to be only one and that was in the last month of the year.
It will be interesting to see how many increases the Fed manages in 2017, at present the market expects three.
In Europe there has been increasing scepticism that negative interest rates and QE are working.
The best performing indices in 2016 were the Russell 2000 in the US (the mid-cap index) which rallied nearly 20%, followed by the Dow Jones
Industrial Average which gained 13% and then the S&P with a near 10% increase.
The NASDAQ index was the worst performer with a gain of 7.5%, however all major US equity markets reached all time highs.
The FTSE100 was the best performer in Europe, rising over 14%, partially helped by the fall in the value in sterling (see below) which helped the
largely international FTSE100 companies become more competitive.
The 14% increase for the FTSE100 doesnt tell the whole story, there was a near 30% swing from the February low to the peak hit in the last
week of the year.
Europe was a lot more mixed as worries continued around the economic situation, particularly in southern Europe and fears for the future of
the Eurozone.
The German DAX managed to rise 7% in 2016, helped by a still strong economy and relatively weak euro.
The French CAC40 only increased in value by 4% and the Italian market, measured by the FTSE Mid, fell over 7%.
Whilst the Italian markets performance is bad it is worth noting that at one stage this market was down 27%!
The major concern for investors in Italy has been the troubled banking system that has been struggling under a huge number of non-performing
loans.
Although private-backed rescue packages have failed to materialise there appears to be a growing belief that one way or another the Italian
banking system will be saved.
At the end of 2016, Unicredit, Italy's largest bank announced a huge rights issue to shore up its balance sheet, even though the new issuance
was bigger than expected the banks stock still rallied, highlighting a renewed optimism.
Much of the rally in the major equity indices came towards the end of 2016, most of the increase coming on the back of Donald Trumps election
victory.
Prior to the US general election most economist had predicted that a Trump victory would be very bad news for markets, some suggesting a
10% initial fall, these predictions proved inaccurate, investors choosing instead to focus on the massive fiscal stimulus package that Trump has
promised.
This promise to 'rebuild America' was the primary reason that the Russell 2000 index was the best performer, the Russell is made up of largely
US focused businesses that stand to benefit most from the increased spending on infrastructure.
For the UK the catalyst for a strong market rally was also from an unlikely source, the UK's vote to leave the EU.
Much like a Trump win a vote to 'leave' was certainly expected to be met with sharp falls in equities and the value of sterling.
After one day of equity falls the FTSE 100 has rallied strongly.
Weak sterling has helped many FTSE 100 companies competitiveness it has also led to some very high profile take-overs, including Softbank's
takeover of ARM Holding and most recently 21st Century Fox's bid for the balance of SKY that it doesnt already own, it will be interesting to see
if this trend continues in 2017 and if Theresa May intervenes in any approaches on the grounds of national security.
As we mentioned in a recent email most investment banks in the US believe that equity markets will continue to rally this year, but at a much
slower pace, investors will be keen to see if Donald Trumps rhetoric does actually manifest itself in higher growth in the US.
Europe has the potential for a changing political backdrop this year with elections in Germany and France.
Economic data, particularly confidence figures have been improving in the UK since they fell sharply directly after the Brexit vote, however it is
important to remember that nothing has actually changed in the UK yet, later this month we will hear the result of the appeal process around
whether parliament has to vote on Brexit.
Sterling finished 2016 not far off its lows against the US dollar, will continued weakness result in outperformance from the FTSE100 or will
investors take the view that the slide will lead to higher inflation without growth?

W H AT Y O U N E E D T O K N O W R I G H T N O W !

GOVERNMENT BONDS:

Ultra-low inflation and in some parts deflation and quantitative easing at the start of 2016 saw the yield on European government debt fall
very sharply with large swaths of German and Swiss debt having negative yields.
The divergent monetary policy between the US and Europe saw 'spreads' between the two regions widen significantly, there was also
divergence within Europe, particularly between Germany and Italy, at the beginning of last year German 10 year debt had a yield of 0.6%, by
the end of 2016 it stood at 0.2%, in Italy it stood at 1.6%, by last week it was 1.8%.
Investors are happy to own safe but low yielding German debt but are much more reluctant to invest in Italy.
US 10 year bond yields have risen from 2.2% last January to stand at 2.44% last week as investors prefer to buy riskier assets such as equities in
the belief that growth and inflation will rise in the country.
Even though European government bond yields are still very low by historical standards they are well off their worst levels, at one stage this
year German 10 year bonds had a 0.2% return, totally unprecedented, so although they now stand at +0.2% this is considerably higher than in
the summer and firmly back in positive territory.
Part of the explanation for the rally in yields comes from a belief that inflation is coming back into the global economy, higher commodity
prices helping this view.
At the end of 2016 the ECB announced that it would extend its QE program but it would be at a smaller amount each month, some
commentators saw this as 'tapering', clearly less Central Bank demand could lead to lower bond prices which in turn leads to higher yields.
In the UK, Gilt yields have come under a lot of pressure, yields on the 10 year have fallen from 2% at the beginning of 2016 to stand at 1.2% in
December.
Prior to the Brexit vote the UK Central Bank, The Bank of England was seen as one of the few that was looking to tighten monetary policy, that
all changed when the UK voted to leave, the Bank of England cut interest rates almost immediately and also increased its QE program.
Whilst gilt yields have fallen further than most other European government debt last year they have risen from the low of just 0.5% in August,
this can be partly attributed to Sterling's precipitous fall which is already stoking inflation in the UK, making any further cuts to interest rates
very unlikely.
The theme for government bond markets for 2017 will probably be focused on inflation and the ECB, is the recent increase in inflation the
beginning of something sustainable or is it just a blip from a very low base?
Will inflation be coupled with growth (clearly we all hope so!) and what will the ECB's future policy look like?
Are markets starting to feel that QE and negative interest rates do not work?

CURRENCIES:

Clearly the fall in sterling has been one of the major events in currency markets in the last twelve months.
Prior to the Brexit vote the pound was trading at $1.5, it touched $1.18 during a 'flash crash' but settled in the low $1.20's after the UK's vote.
There is a pretty consensual view that sterling will stay under pressure, it finished down 17% against the US dollar in 2016.
In the last couple of months of 2016 sterling actually held up relatively well, (was it was more about US dollar strength post the Trump victory?)
The euro has weakened against the US dollar, trading at $1.05 with many commentators predicting parity in the first half of 2017.
The ECB will not be unhappy that the euro is weaker, helping the export led economy.
The US dollar has traded at a 14 year high recently, higher interest rates in the US helping and a belief that the US economy will grow more
strongly than most other developed countries.
The Japanese yen has also been a feature, even though it is pretty much unchanged on the year it did hit 100 to the US dollar in August before
finishing at 1.17 in December, its lowest level for several months.
Japanese PM Abe has continued to put his faith in QE and has made clear his determination to keep the yen low.
The Chinese government controls the 'peg' for the yuan against the US $, setting the rate daily, the currency is then allowed to trade in a band.
In 2016 the Chinese allowed its currency to fall, but unlike in 2015 when they devalued the yuan in a shock move that caused turmoil in all
markets they have moved the currency lower over a prolonged period.
The yuan started 2016 at 6.45 to the USD, it finished last year at 6.95.
It appears that the Peoples Bank of China is happy to tolerate inflation in exchange for growth.
The Russian rouble strengthened last year, along with other oil exporting nations currencies as the price of oil hit recent highs (see below).
The Russian economy has suffered with two years of recession created, partly by the collapse in oil prices, the country derives over half of its
revenue from oil exports.

W H AT Y O U N E E D T O K N O W R I G H T N O W !

COMMODITIES:

Probably the biggest story in commodity markets last year was the movement in the price of oil.
In 2014 the price of Brent crude, the international benchmark fell from $120 to hit a low of under $30, with some analysts predicting it could
hit $10.
During the market falls of February of this year Brent stood at $36 per barrel, since then there has been a sustained rally, finishing 2016 at $57
per barrel.
For the last two years Saudi Arabia has been happy to pump at record levels in an attempt to make the US shale gas industry uneconomic,
however it became clear that the US oil market was a lot more resilient than the Saudi's thought.
The Middle Eastern kingdom was burning through its currency reserves at an alarming rate, from the middle of last year it became clear that
OPEC and other oil producing nations were prepared for concerted and co-ordinated action which culminated in an agreement at the end of
November 2016.
OPEC members agreed a production cut as well as a commitment from some non-OPEC member such as Russia to slow production.
The rally in the oil price is even more impressive when you consider the continued strength of the US Dollar that usually creates a headwind.
We mention above the rally in oil is also helping some of the beleaguered emerging market countries that rely so heavily on oil exports.
The Trump victory has also helped the price of industrial commodities such as copper and iron ore which have seen some sharp, if volatile,
price increases in the last quarter of 2016 on the belief that the fiscal stimulus in the US and better economic data from China will lead to
greater demand.
It has been a different story for gold, the precious metal is small up on the year but is 17% off its summer highs.
The metal had benefited from ultra-low interest rates and its 'safe haven' status as markets worried about Chinese growth and deflation in
Europe, however since Trump's election win and December's interest rate rise the yellow metal has lost its shine, the stronger US dollar has
also weighed.

Markets are leading indicators, that is they factor in events before they actually materialise, often equity
markets start to rally before the economy improves.
Last year was no exception, the oil price is higher on the belief that OPEC and other oil producers will follow
through with their agreements and cut production, this has typically been a challenge and there is no
reason the believe it won't be this time.
Equity markets have rallied, particularly in the US on the 'hope' that Donald Trump will follow through with
his election pledges and growth will strengthen.
UK equity markets have taken the view that Brexit will not be as harmful as the most dire predictions and
that sterling weakness will outweigh any slowdown.
The US dollar is at a 14 year high partly due to the belief that US interest rates will rise another 3 or 4 times
next year and that the countries GDP will continue to grow, US interest rates were supposed to be raised 3
times in 2016, the Fed managed this just once and that was in December!
All of the above will have an impact on government debt markets, at the moment it appears that investors
are sure we have seen the end of ultra-low inflation, if the price of oil falls and growth continues to be
lacklustre that may not be the case.
I suspect that we will be in for another volatile year but as we saw in 2016 we should all expect the
unexpected but that may not be a bad thing.
As ever if you have any questions or comments please don't hesitate to get in touch.
We would like to wish you all a Very Happy New Year.