The year ahead: Central banks to lose sway over world markets

Central bank dominance of world financial markets is likely to ease or even disappear in 2017.

This will depend on tightening monetary policy and brighter economic fundamentals.

The long period of ultralow interest rates and central-bank asset buying has boosted the prices of bonds and safe stocks.

Instead, investors can expect economic performance to take over as the primary source of asset growth.

That means turning to riskier assets and a continuation of the end-of-year rally, while bonds and more defensive stocks will continue to underperform.

In the past year, Wall Street shook off its worst-ever start to a year to log its best performance since 2013.

The blue-chip benchmark Dow Jones Industrial Average index gained 13% in 2016 even as it closed 0.3% lower at 19,763 on the final trading day of the year and tantalisingly short of the 20,000 milestone.

The S&P 500 added 9.5% in 2016 and the Nasdaq Composite rose 7.5% for their biggest gains since 2014.

Bull market continues
Last year’s rally extended a bull market that has tripled the Dow from its low of 6547.05 during the global financial crisis in March 2009.

During 2016, stocks weathered several shocks, including a recession scare in the US, Brexit and the presidential election of Donald Trump.

The good news for 2017 is that investors will now focus more on company profitability and credit risk, as they spend less time analysing central bankers’ speeches word by word.

Since the GFC, central banks have unleashed massive asset-buying programmes and kept interest rates at historically low or even negative levels to help stimulate growth and inflation.

While thee European Central Bank is still buying government and corporate bonds, the rate has diminished.

The US Federal Reserve nudged up rates by a quarter of a percentage point in December and pledged a series of hikes in the future.

After a one-day tizz, the election of Mr Trump fuelled a sharemarket rally based on promised policies of infrastructure spending, lower corporate taxes and easing financial regulation.

Riskier assets rise
Since November, those shares in the MSCI World index more exposed to economic swings, or cyclical stocks, have gained 10%.

Safer, or defensive, stocks on the index went up only 4.6%, despite having outperformed since the financial crisis. Relative to defensive stocks, the prices of cyclical shares are now at their highest since 2008.

Eurozone banks took a beating for much of 2016 but have recovered some ground after a big rally in the past two months.

By contrast, global bonds have lost 5% in the past two months. Yields of 10-year US Treasurys are at 2.446%.

The question is whether companies will prove profitable enough to justify the market’s risky bets for 2017.

Commodity prices rise
Higher commodity prices also have boosted inflation expectations.

Oil in 2016 had its biggest annual gain since the financial crisis, even in a year that also sent prices dipping to a decade low.

US crude finished the year up about 45% at $US53.72 a barrel, while Brent, the global benchmark, was up 52% at $US56.82.

It was their biggest yearly gains since 2009 on the back of a strong year-end that brought four winning months in the last five.

Gold snapped a three-year losing streak with prices rising 8.5% in 2016, Most of those gains were in the early part, rising 16.5% in the first quarter.

Since then it has come under pressure from a rising US dollar and tightening monetary policies that boost interest rates.

Gold ended the year down nearly 15.7% from its July peak at $US1364.90 an ounce.

The prospects for gold don’t look much better this year as it struggles to compete with rising returns from yield-bearing investments and depressed demand from China and India as the dollar rises.