Bright Spots in 2017
It's not all doom and gloom for investors in 2017 as HSBC Global Research highlights six potential positive surprises for the year ahead.
Market outlook has generally skewed to the downside since late 2014, and heading into 2017 is no different following the political shocks of Brexit in the UK and the election of Donald Trump in the US.

Amidst a backdrop of political uncertainty alongside concerns about tepid economic growth and adverse geopolitical developments, HSBC Global Research believes that we could be in for some positive surprises in 2017 that could challenge consensus and HSBC Global Research's own expectations.
Here are the six possible positive surprises compiled by HSBC Global Research for 2017.
01
US PRODUCTIVITY
REVIVAL
US productivity performance
is expected to resuscitate following President Donald Trump's campaign pledge to enact a fiscal policy package by the middle of 2017 involving reduced tax rates as well as new provisions to encourage domestic investment. This could help to revive US labour productivity from the less-than 1% growth over the last five years towards 2% or higher in 2018 and beyond.
HSBC Global Research is positive that President Trump's fiscal policy agenda could lead to faster growth in the capital stock. And perhaps even more importantly, the combination of new business incentives and efficient public infrastructure investments could lead to an increase in business dynamism and an acceleration in total factor productivity growth.
Investment implications
A productivity boost driven by fiscal stimulus would generally be positive for risk.
The main question under this scenario would be the US Federal Reserve's reaction function and whether or not a more aggressive hiking path would come into play.
Good for the USD
The USD responds to the cyclical move higher in yields strengthening against G10. Emerging markets (EM) may struggle against the USD initially but then recover as yields stabilise.
Good for equities
Global stocks may rally with Europe outperforming the US. EM stocks could do well providing the US Federal Reserve (Fed) doesn't raise rates aggressively.
Positive for credit
Credit should rally on higher profit margins. However, aggressive rate hikes and/or a significant tightening of financial conditions could pose problems for US and EM credit.
Mildly negative for bonds
Higher nominal and real bond yields though there is likely to be a ceiling to nominal bond yields due to structural factors.
02
STATUS QUO
FOR EUROPEAN GOVERNMENTS
While concerns about
populist parties coming to power in Europe have heightened with upcoming elections in Germany, France and the Netherlands soon, as well as the possibility of snap elections in Italy and Greece, polls across Europe towards the end of 2016 suggest that mainstream candidates would prevail in the 2017 elections.

If populists lose convincingly, Europe could surprise on the upside in 2017. Cleansed of bad loans, Italy's banks could start lending again.
Spain's stellar growth could continue, unchecked by another round of political uncertainty. In France, Presidential frontrunner Francois Fillon's plans include more market-friendly measures to address public spending and tax cuts for businesses. While in Germany, a new Angela Merkel administration, while unlikely to go on a fiscal splurge, could loosen policy slightly. All of which could put 2017 Eurozone GDP growth closer to 2% than HSBC Global Research's central case of 1.3%.
Investment implications
A loss in momentum for populist parties in Europe could lead to a relaxation of fiscal austerity in the major core and periphery Euro countries.
Generally, HSBC Global Research is expecting relative periphery risks to diminish and investment flows from global investors to intensify.
Bullish for the Euro
Any redenomination risk would be priced out of the Euro and Central and Eastern Europe currencies will benefit the most.
Bearish for German bond
The flight to quality premium that was priced in pre the start of the election cycle will reverse. Periphery to core spreads would likely compress.
Very good for European equities
Higher beta periphery could outperform the low beta UK and Switzerland. Domestically focused sectors could outperform defensives. Europe will outperform EM and the US.
Bullish for high volatility European credit
In particular AT1 (additional tier-1 securities and contingent convertible capital instruments), corporate hybrids, periphery and EUR HY (Euro high yield corporate bond) could outperform EUR IG as the necessity of the CSPP is questioned.
03
GLOBAL TRADE
RISES
The post-recession period
has not been kind to trade. This century opened with a period of robust growth for trade with annual increases in exports outpacing GDP by a ratio of more than two to one in some years. After the recession and initial recovery, the export pace slowed to be more in line with GDP. Then, in 2015 and 2016, exports failed to even keep up with GDP. The world economy became less trade intensive with weak aggregate demand - especially weak investment spending, which is trade intensive - accounting for much of the slowdown. Other factors also weighed on trade including a rise in protectionism and lagging trade liberalization efforts.

In addition, the emergence of inward-looking populist political sentiment in Europe and the United States - like the Brexit vote and President Trump's election promise of putting in place protectionist measures like withdrawal from the Trans-Pacific Partnership and imposition of increased tariffs on US suppliers such as China and Mexico - compounded the gloom.

Thus, it is not surprising that expectations for a rebound in trade during 2017-2018 are fairly low. Yet, there is an underlying possibility of a trade surprise.
There are four major trade accords still in the works. And investment spending could be revived via new policy initiatives.

Amongst the major trade accords in the works, Asia's Regional Comprehensive Economic Partnership negotiations are at a mature stage, and if completed, this accord could liberalise trade among 16 countries that account for nearly 1/3 of global GDP and boost economic welfare in the region by about 1.8%. At the global level, the WTO's Trade Facilitation Agreement is nearing ratification. This accord would streamline customs procedures, cutting the cost to trade by roughly 15% and potentially boosting goods trade by USD 1 trillion (WTO, World Trade Report, 2015).

The reduction in trade barriers and the positive signals to markets would help boost trade. And further gains could come if this were complemented by a rise in investment, perhaps fuelled by increased infrastructure spending in Asia, Germany and the US.
Investment implications
Generally, a rise in global trade would benefit EM assets across the asset classes.
In particular HSBC Global Research believes it would drive demand for commodities and assets in countries with high trade exposure. HSBC Global Research also believes EM carry trades will make a major comeback.
Positive for capital flows to EM
With improving global trade/EM growth, higher commodity prices, re-accumulation of reserves and re-cycling of petro-dollars would boost risk appetite hence portfolio investment into EM, particularly into EM equities and carry trade strategies.
Mildly bearish for bonds
Improvements in growth associated with a softening of Trump's protectionist rhetoric could reinforce the belief that there is potential for a more hawkish Fed.
Positive for commodity and energy credit
As commodity prices rally, commodity and energy focused credit could tighten as default rates fall.
Good for European and Asian equities
European equities earn 50% of their revenues from outside of Europe and Asian world trade plays will benefit.
Positive for G10 commodity and most EM currencies
AUD, NZD, CAD and SEK in G10 and Asian FX in EM. Latin America FX could benefit as fears about scrapping NAFTA subside.
04
A SMOOTH BREXIT
TRANSITION
Although the odds are in
favour of a disruptive implementation of Brexit peppered with uncertainty and detrimental to growth in the UK, HSBC Global Research says there could be another scenario that involves a smooth and painless transition.
According to HSBC Global Research, European negotiators may choose a pragmatic approach allowing for a lengthy transition period, while the UK may be able to negotiate a relatively favourable deal on trade.
Investment implications
Positive for the Pound
GBP would rally to the post-referendum range of 1.30-1.35 against the USD.
Positive for UK domestically-focused equities
Favouring small and mid-cap over large.
EURUSD would rise slightly
Political compromise to achieve a smooth transition is viewed as a positive for the single currency.
Stronger growth likely to push European cyclicals higher
However the risk premium is likely to remain elevated given the risk that another country may try to follow the UK route.
05
US DOLLAR
LIQUIDITY IMPROVES
The current US Dollar shortage
has increased hedging costs for Japanese and European investors, and non-US banks are suffering constraints on US Dollar funding.
HSBC Global Research believes there is a possibility that central banks acknowledge the negative impact of the shortages and preemptively move to address the issue. Such a move would change the underlying risk assessment for global investors.
Investment implications
Positive for EM equities
Via greater liquidity.
Positive for non-US borrowers
For borrowings in USD.
Recovery of EM FX current account deficit
As high yields become attractive again.
USDJPY lower
As concerns about much higher hedging costs for local investors fade.
Support the front-end of the US curve
Boost the performance of US Dollar Libor trades that have already been positioned.
The anomaly in cross-currency basis will start to reverse
With policy response in the form of an increase in the supply of US Dollar.
Positive for global financials and short-duration equity sectors
If it results in steeper yield curves.
Good for EM economies struggling with large external financing requirements
Countries like Malaysia, Mexico, South Africa and Turkey may feel less pressure and could even ease liquidity conditions, helping financial flows.
06
China Speeds Up State-Owned
Enterprises Reform
The Chinese government
has been actively promoting initiatives to make the state sector more efficient. Companies in China's debt-laden state sector, which represents about a quarter of the country's economy, are being put under increasing pressure by senior leaders to improve their performance
The pace of these reforms may exceed market expectations in 2017, as policy makers aim to see results ahead of the major party conference that is likely to be held in November 2017. Even though this surprise may be focused on domestic policies in China, it is likely to have global implications.
Investment implications
Less downward pressure on the Renminbi
This would also mean less downward pressure on other Asian currencies, and the AUD and NZD would stabilise.
Reduced risk premia for EM equities
With reduced perceived risk of a Chinese hard landing, commodity plays would be the main beneficiaries.
While it is important to remain cautious in 2017, it is worthwhile keeping an eye on these potential positive surprises for 2017 and review your investments to take advantage of them throughout the year.
This article above is a summary of HSBC Global Research's Top Surprises for 2017 report published on 5 January 2017.