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Macroeconomic climate
Looking at the year as a whole, the expansion of the global economy in 2016 once again fell short of the previous year at 3.1% (previous year: 3.2%). In the second half of the year the economy benefited from a tangible upward trend: the growth rate of 0.9% recorded in the third quarter was actually the strongest in two and a half years.
The pace of growth in the advanced economies remained moderate, even though manufacturing picked up appreciably from the summer onwards. Impetus derived from, among others, the United States, where inventory investments and exports increased sharply after a depressed first six months. In Japan total economic output rose slightly thanks to a boost from exports. The Eurozone economy continued to expand in 2016, sustaining its moderate growth of the past three years. It was stimulated by private and public consumption and in regional terms enjoyed broad-based support.
Growth in emerging markets was again stronger in 2016, although the economic challenges facing individual countries remain considerable. In China, India and other Southeast Asian nations output surged sharply higher over the six months of summer – driven in part by an expansionary economic policy. In Latin America it was above all Mexico and the Andean countries that picked up on this trend. Brazil, Argentina and Venezuela, on the other hand, remained mired in recession. Output in Russia stabilised again after a soft spring. Economic activity in Turkey suffered an outright collapse following the political turmoil of the summer.
United States
The US economy proved unable to maintain the previous year’s pace of growth. Gross domestic product (GDP) rose by just 1.6% in 2016, a full percentage point less than in the year before. The principal factor here was a soft first six months. While private consumption was still lively, businesses in particular showed marked reticence with their investments in equipment. The trend reversal in the summer was crucially driven by the fact that companies began to rebuild their stocks after five quarters of reductions. What is more, exports started to pick up again. Consumer prices showed another year-onyear gain (+ 1.3% as against + 0.1% in the previous year) and unemployment fell by a further 0.4 percentage points to a comparatively low level of 4.9%, suggesting a fundamentally positive basic tendency in the United States.
Europe
The economic climate in the Eurozone maintained its moderate expansionary course: the growth rate fell slightly by 0.2 percentage points to 1.7%. The growth contribution stemming from foreign trade remained modestly negative in the year just ended at -0.2%. In regional terms, the economic expansion was broad-based, with all the nations in the single currency area managing to boost their economic output. Even countries currently facing an intensified struggle with economic difficulties – Portugal (+ 1.3%), Italy (+ 0.9%) and Greece (+ 0.4%) – charted a growth course. The UK economy expanded by 0.5% in the third quarter, notwithstanding the vote in favour of leaving the European Union. Not only private consumption and corporate investments but also exports surged appreciably, contributing to growth of 1.6% for the year.
The state of the labour market in Europe continued to improve. The average jobless rate decreased by 0.8 percentage points to 10.1%, with above all Greece and Spain still struggling to cope with high levels of unemployment. Consumer prices, which had been flat in the previous year, increased by 0.2%.
Germany
Having enjoyed an upswing over the past three years, the German economy stayed on its expansionary track in 2016. Growth increased again by a modest 0.2 percentage points year-onyear to reach 1.9%. In view of the political uncertainties in the international arena, the willingness of companies to invest softened appreciably over the six months of summer. By yearend, however, economic activity was clearly trending higher again. Low interest rates continued to stimulate spending by private households. The construction industry, in particular, was still operating at the limits of its capacity, with orders on hand standing at their highest level in 16 years at year-end. Private consumption once again played a pivotal role in the favourable economic development: it benefited from a healthy jobs market, rising real wages and an oil price that was still moderate. German exports overcame a temporary period of softness to put on 2.5% over the year as a whole. Furthermore, industrial new orders from countries outside the Eurozone also surged vigorously in the final months of the year.
The state of the labour market was positive: according to figures published by the Federal Statistical Office, the average number of persons employed over the year increased by 1.0% to a new record high of 43.5 million. The jobless number fell to a historically low 1.76 million, equivalent to an adjusted unemployment rate of 4.1%.
The price trend was positive in 2016 despite the restraining effect of low energy prices. Consumer prices rose by an annual average of 0.5% (0.2%). In December they increased by as much as 1.7% compared to the same month of the previous year.
Asia
After the rather moderate pace of expansion in 2015 growth was still sluggish as 2016 got underway, but it picked up perceptibly over the course of the year. In China, most notably, gross domestic product rallied strongly during the year thanks to an expansionary economic policy and by year-end it modestly surpassed the growth target set by the government. At 6.7%, however, the increase fell 0.2 percentage points short of the previous year.
In India the implementation of currency reform in late autumn severely hampered economic activity towards the end of the year. Despite this, the growth of 7.1% recorded by Asia’s second- largest national economy was not far short of the previous year’s good performance (+ 7.3%). Growth was similarly sustained in the other emerging nations of Southeast Asia: the four economies of Indonesia, Thailand, Malaysia and the Philippines expanded by an average of 4.8%.
Japan was able to boost its exports to the Asian region in the second half of the year despite a strengthening yen. Private and public consumption as well as gross investments remained flat, however, as a consequence of which the country’s economy continued to show only slow growth of 1.0% over the year as a whole (+ 1.2%).
Capital markets
The investment environment in the period under review was once again challenging and notable for a high degree of uncertainty. Even as the year got underway China unnerved financial markets by devaluing its national currency; this prompted concerns about the state of its economy. The fall in commodity prices as a consequence of excessive supply capacities, global growth worries and a strong US dollar impacted emerging economies first and foremost, but also had sharply negative implications for Western equity markets. The European Central Bank (ECB) and the Bank of Japan responded by extending their expansionary policy, and the pause in the cycle of interest rate hikes announced by the US Federal Reserve (Fed) in the fourth quarter unleashed a rally on stock markets.
The general mood of uncertainty prevailing on financial markets was further exacerbated by the referendum held among the UK population in the middle of the year on leaving the European Union (“Brexit”). From the end of June onwards the doubts surrounding the outcome of this vote gave way to political and legal uncertainties in relation to the concrete procedure for leaving the EU. This situation led to protracted volatility in the United Kingdom, where further sharp declines in yields were observed across all maturity segments until the beginning of the fourth quarter as a consequence of support buying by the Bank of England. German and US government bonds, however, similarly saw clear decreases in yields until the same point in the year. Yet as the fourth quarter began a trend reversal towards rising yields emerged – and subsequently gained further momentum following Donald Trump’s victory in the US presidential election in early November. Looking at the entire year, US Treasury securities showed increases in yields across all maturity bands. When it came to the euro and pound sterling, on the other hand – despite the upticks in yields in the fourth quarter –, further considerable declines in what was already a low yield level were seen over the year as a whole. German government bonds at times delivered clearly negative returns almost into the ten-year maturity segment.
Uncertainty also left its mark within the year on the valuation of markets for corporate bonds – primarily at the start of the year in emerging economies – and initially prompted sharp rises in risk premiums. Over the course of the year, however, these increasingly retreated again across all rating classes – sometimes falling appreciably below their respective level in the previous year.
The policies pursued by central banks in our main currency areas varied. Following its cut to 0.05% in 2014, the European Central Bank (ECB) further trimmed the key interest rate for the Eurozone at the beginning of the current reporting period to the historically low level of 0.00%. The Bank of England – which had left the prime rate for pound sterling untouched since 2009 – followed suit by reducing it from 0.5% to 0.25% in response to the Brexit vote. The Fed, on the other hand, raised the base rate for the US dollar slightly from an average of 0.38% to 0.63%.
Stock markets, which we had begun to look at more closely again in the context of our move to rebuild an equity portfolio, climbed to new – in some cases – historic highs in the course of the year. The US market, in particular, booked appreciable price gains over the year. Most European indices, on the other hand, found themselves treading water year-on-year, although the DAX 30 performed relatively well with a gain of some 7%. Markets in emerging economies also delivered a pleasing performance, especially bearing in mind their slump at the start of the year. European equity markets were driven above all by the continued expansionary monetary policy of the ECB and the search by investors for high-return investment opportunities. With this in mind, though, the high price levels were ultimately only partially justified by fundamental metrics. All in all, stock markets once again proved to be broadly robust in the face of crisis warnings. While this is a cause for satisfaction, it can also entail the risk of bubbles forming. It was only growing concerns about the strength of the Chinese economy following a currency devaluation in combination with slumping commodity prices that prompted a marked downturn on stock markets at the beginning of the period under review.
The development of the world economy remains subject to various uncertainties and risks, first and foremost of a geopolitical nature. Global heterogeneity associated with varying economic trends and local flashpoints may be mentioned here as particularly significant considerations. The ongoing risk of terrorism is another factor that needs to be monitored, even though capital markets have hitherto responded to this in robust fashion.
The euro declined again against the US dollar over the course of the year from USD 1.08 to USD 1.05. It also suffered some modest losses against the Australian dollar. The pound sterling, on the other hand, fell sharply against the euro as a consequence of the Brexit vote, with the euro climbing from GBP 0.74 to GBP 0.86.
For more detailed remarks on the development of Hannover Re’s investments please see the Investments section.