With many of the geopolitical drivers of uncertainty in 2016 having now passed, Thesis Asset Management portfolio manager Gaurav Gupta is getting ready to deploy its cash holdings in 2017. 
The past year saw a number of key economic events unfold such as the Brexit vote and US presidential election. But while the results have thrown up further questions about the outlook for the global economy and the impact on markets, Gupta says now is the right time to reduce cash exposure.
“One of the reasons we’re thinking it’s a good time now is [that] looking forward there may be potential European problems, there may be potential Japanese problems. But the two risks that we positioned for this year [Brexit and the US general election] are over so we can now invest more certainly in some of our high conviction ideas,” he said.
Performance of indices in 2017
Source: FE Analytics
While these events have impacted the markets to a certain degree, both the FTSE 100 and S&P 500 are ahead this year, with the MSCI World index also rising.
Despite the relative lack of clear-cut buying opportunities these events have therefore presented, Gupta says it is time to get cut its cash weighting, as higher inflation looks set to make a return in 2017.
While the consumer price index (CPI) eased back to a below-consensus 0.9 per cent in October from the 1 per cent figure in September, many expect inflation next year to rise sharply.
Indeed, the Bank of England recently forecast that inflation will rise to 2.7 per cent by the end of 2017, meaning that investors holding cash could miss out on gains elsewhere.
“The other reason we want to actively get cash off our portfolios because we’re seeing a spike in inflation in the UK,” Gupta said.
“If inflation is predicted to be over the next 10 years an average of 3 per cent - and we’re getting that forecast from the 10-year breakeven rate - and in our cash accounts we’re getting zero per cent interest, we’re effectively losing 3 per cent each year.
However, analysts remain mixed on the long-term prospective of inflation, with Architas investment director Adrian Lowcock saying inflation is set to disappoint.
He said: “Some people have said 2.5 per cent, the Bank of England is at 2.7 per cent: I think we’re expecting a little higher than that. But I think a lot of people are anticipating that inflation is back and that now we have inflation suddenly deflationary signs have all gone away.”
“Whereas 2015 was a year of no inflation, I think 2017 will be a year of inflation – I think it will be on the agenda – however I think it will probably disappoint in the end.”
“Compared to some of the forecasts of 4 per cent I think what it will be is you will get is it will be a blip in inflation and it will come off because there is nothing to drive the underlying inflation.”
He says this is due to the two biggest factors impacting markets - the fall oil price and the fall in the value of sterling – already being priced in.
“You can be reasonably confident that the oil price isn’t going to double again, we’re not going to up to $100 [per barrel] so the oil price inflation is only a one-off. It still might rise a little bit but the inflationary effect of that is going to be less.”
Additionally, he says the pound has “found a level now” adding that he does not expect it to fall again.
Performance of sterling vs US dollar in 2016
Source: FE Analytics
Indeed, since October the UK’s currency has balanced against the US dollar though it has lost 15.83 per cent so far this year.
While both these factors will drive inflation up into the first and second half of next year, most of the weakness will have played through by then, he says, and inflation will likely peak.
However, others are more concerned, with Schroders head of commodities Geoff Blanning noting that there is a big expectations component to inflation.
“Once commodity prices rise, obviously consumer price is going to go up, the price of petrol and food, et cetera is going to rise, and its then that the inflationary psychology really matters.”
“If people really expect inflation to continue that’s when they start changing their behaviour and companies will start buying in higher inventories of commodities they need and airlines for example will buy a lot more oil in advance and all these things drive up inflation and lead to more inflation.”
“We compare inflation to someone with a bottle of ketchup. We’ve had all this money printing and with ketchup you’re trying to get it out of the bottle.”
“You keep shaking and it doesn’t come and then suddenly it comes all at once and that what’s going to happen with inflation - once it takes hold it can take hold very quickly.”
Gupta says that he is looking at short duration bonds as a low-risk income-yielding asset and to US equities, where despite a surprisingly resilient response to the president-elect, there may be future opportunities.
“The US is expensive but I think if there is volatility from Donald Trump winning the US elections it would be a good time for us to get direct dollar exposure,” he said.
So far the market has performed well, rising above the pre-election levels to stand 29.71 per cent higher on the year-to-date.
Performance of index in 2016
Source: FE Analytics
“The economy is strong, they have got very low unemployment and they’ve got signs of wage inflation coming in,” said Gupta.
“We’ve seen more mergers and acquisitions in the US economy, we’re seeing signs of a more mature economy and, given that, we do see there is the potential for them to grow given that interest rates are so low.”