In her most recent speech, Yellen said it could be a policy mistake to be too slow to raise rates further. Looking at forthcoming Fed decision dates, currently the futures markets think a March 15 increase is possible (roughly 30% chance), and a May 3 increase is a real chance (50:50 call), while a 0.25% increase by June 14 is odds on, with further increases by the end of this year.

Bonds will also be challenged by rising inflation, in the U.S. and elsewhere. As noted in the international equities section, the most recent fund managers’ surveys show they now expect faster world economic growth and higher world inflation, and the most recent data also point in the same direction. In the U.S., for example, the headline annual rate of consumer price inflation in January was 2.5%, and even excluding surging fuel prices, was 2.3%. Recent inflation data in Germany (1.9%) and the U.K. (1.6%) also show how the inflation tide has turned.

As a generalisation, bond yields that had been at all-time lows in a world of zero inflation (or even outright deflation in some places) are now anomalous in today’s circumstances. There are some country-level wrinkles—Japan, for example, has had less success in getting inflation back up to more normal levels—but as a rule, trends in the global economy are unfavourable for bondperformance.

Finally, there is the Trump factor. Nobody knows for sure what his economic policies will be, how they will play out, or how they might inter-react with his geopolitical ideas. The initial reaction from the U.S. bond market was that the biggest moving part would be fiscal stimulus, which would tend to raise bond yields over time, and that is probably the best way, for now, to think about the impact. As noted earlier, the latest Wall Street Journal poll of U.S. forecasters thinks there will be a 0.5% increase in U.S. 10-year yields during the course of this year.

Faster global growth, higher global inflation, and tighter monetary policy combined with looser fiscal policy in the U.S., is a combo that is cyclically unfavourable for bond market prospects. It does not help that investors (like those piling into higher risk bonds) who are hoping to wring some extra return off the beaten track are also running out of options. Credit spreads have now been driven down to historically low levels, and may be too low to compensate for the extra risk.

International Equities — Outlook

There are two dominant and somewhat conflicting themes affecting the outlook for global shares: evidence of stronger global economic activity, countered by rising levels of risk and uncertainty.

On the positive side, the latest global business surveys are encouraging. The January reading for the JP Morgan Global All-Industry Index (covering both manufacturing and services) was at a 22-month high, with JP Morgan commenting that the January data “provides a positive picture for the global economy at the start of 2017. Rates of expansion improved for both output and new orders, leading to further job creation and rising levels of business confidence. The global economy looks well set to build on this solid start during the remainder of the quarter.”

Global fund managers are also buying into the idea that the world is looking up. The latest (February) survey by Bank of America Merrill Lynch (BAML) showed roughly a quarter of them now think the world economy will be growing faster than usual this year, whereas a year ago, virtually nobody did. Similarly, a year ago, 88% of the managers thought that the outlook was for more “secular stagnation,” a prolonged period of low growth and low inflation. There are still a fair few pessimists around (43%), but their number has more than halved.

But alongside this improving outlook, virtually every forecaster has also been pointing to higher levels of risk and uncertainty. In the latest update to its Global Economic Prospects forecasts, for example, the World Bank said 2016 looks to have been the low point for world post-GFC growth, and that this year, 2018 and 2019 will all be somewhat better. It is expecting slightly improved performance in the developed economies and clearly better performance in emerging and middle income markets (notably Argentina, Brazil, Nigeria and Russia).

But the World Bank also said that “Uncertainty surrounding global growth projections has increased and risks continue to be tilted to the downside. This reflects the possibility of a prolonged period of heightened policy uncertainty following recent electoral outcomes in key major economies, mounting protectionist tendencies, and potential financial market disruptions associated with sharp changes in borrowing costs or exchange rate movements.”

The BAML survey also found that fund managers had several worries on their minds. In order of importance, they were: a breakup of the eurozone; potential trade wars under a Trump administration; potential financial stress caused by either a strong U.S. dollar or higher interest rates; and unexpected “financial events” such as bank failures.

It is not all bad news. As the World Bank said, “significant fiscal stimulus in major economies—in particular, the United States—could support a more rapid recovery in global activity in the near term than currently projected, and thus represents a substantial upside risk to the outlook”. The result is that the range of potential outcomes is wider than ever.

Oddly, however, from various perspectives, equity markets do not seem to be behaving as one might expect when risk and uncertainty are as high as they are currently. For one thing, investors continue to have unusually low expectations for volatility in the U.S. share market, despite the obvious potential for large surprises (good or bad) from the Trump administration or from other unexpected events. The VIX index of the S&P500’s expected volatility continues to trade at unusually low levels, as do measures of expected volatility in other equity markets. For another, a natural reaction to uncertainty would be to discount the likelihood of good things happening, whereas investors are currently putting a high price on expected earnings. In the U.S., for example, S&P estimates that the S&P500 is priced on 24.3 times historical earnings and 17.4 times projected earnings (other analysts have similar estimates), which are historically high valuation levels.

Perhaps the optimists will be proved right and growing momentum for the world economy will carry the day, and none of the economic, political or financial risks will prove material enough to derail the underlying support for improved corporate profitability, or they might—if there is indeed a big positive tax surprise on the way from the Trump administration—further boost economic growth. But at a minimum there are likely to be recurrent reality checks (along the lines of those we saw on several occasions last year) as investors revisit the likelihood of setbacks to currently optimistic expectations.

Performance periods unless otherwise stated generally refer to periods ended February 14, 2017

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