Diverging economic growth and policy trends in the year ahead is going to make it increasingly difficult for global investors and portfolio investment choices according to economists and market analysts.
With the world’s two largest economies—US and China—set to diverge on monetary policy and a contrarian expectation of further weakness in China, next year’s market outlook is fraught with credit, rates and currency risks, Gulf News reported.
Policy divergence is seen as a key theme for 2016, as the Federal Reserve, The Banco Central do Brasil and a few other central banks intend to tighten monetary policy, while most—including the European Central Bank and the Bank of Japan—take the opposite path. This split will occur against a backdrop of modestly rising global growth and inflation. As a result, analysts say the risks of a hard landing or a recession will be low.
“We are not fans of the gloom-and-doom stories of a Chinese hard landing or looming recession in the US or other developed markets. Chinese authorities have both the room and the incentives for further policy easing to preclude a more adverse deceleration in growth … The combination of a deep downturn and gradual recovery likely means there is still room for the US economy to expand,” said Ethan Harris, Co-head of Global Economics Research, BofA Merrill Lynch.
Growth in Europe
With further monetary and fiscal stimulus, analysts expect to see continued above-trend growth in Europe. Further weakening in the euro exchange rate should also help although most of the strength is coming from domestic demand. The coming year is likely to be the fourth in a row with inflation hovering around the 1% level.
China is struggling as it restructures away from exports and investment in favor of consumption and services. "We expect the government to continue to implement monetary and fiscal stimulus until growth stabilizes", he said. However, the longer-term outlook is for a gradual slowing in growth.
“In the financial world the key trend will be monetary policy divergence as the US and UK start to tighten—albeit very slowly—while loose policy persists elsewhere. China will be on everybody’s radar and a stronger US dollar will continue to impact upon emerging markets, although I believe that more of this is priced in than anticipated," Marc Norden, Head of Asset Management, BLME, said.
Moving in Reverse
Rate normalization and rising cost of funds will be a key deciding factor of US equities. “For 30 years, investors have gotten used to falling interest rates and easy-money policies. That’s not going to be the case in 2016. Our simplest advice for the year: Do the opposite of what worked for you before,” said Savita Subramanian, Head of US Equity and Quantitative Strategy, BofA Merrill Lynch.
Analysts see credit-sensitive investments as 2016’s biggest risks. Thankfully most companies in the Standard & Poor’s 500 are large and highly liquid and have healthy balance sheets and above-average cash balances.
“We expect the S&P 500 to continue climbing next year. Our year-end target is 2,200, up from about 2,100 now—a rise of 5%. Further ahead, we see the S&P 500 hitting 3,500 in 10 years,” said Subramanian.
Analysts say some inherent bearish trends in the market can’t be ignored. There are lingering bearish risks in the current slow-growth environment. But the possibility of a late-stage bullish surge remains.
QE Impacts
The outlook for European equities in 2016 is not going be fundamentally different than it has been for several years, particularly given the potential for incremental stimulus from the European Central Bank and its knock-on impact on bond yields and therefore equity prices.
Whatever the short term effects might be, analysts say quantitative easing has the implicit aim of embedding inflation. This has important implications for portfolio construction.
Analysts see the potential quantitative easing by the ECB to reflate the economy which will be a key factor in equity performance. Lower rate for longer period is expected to benefit stocks in general and value stocks in particular.
The slow but steady economic momentum taking shape across Europe is going to be a key driver of market performance.
EM Recovery
For the first time since 2010, average annual growth in emerging markets should begin rising to 4.3% in 2016 from 4% in 2015 according to BofA Merrill Lynch. Excluding China, growth should pick up to 3.1% in 2016 from 2.6% in 2015. About three-quarters of emerging market economies could show signs of recovery by the middle of 2016, whereas Brazil could contract further to -3.5% as it struggles to climb out of recession.
“As China continues its shift to a consumer-oriented economy, its growth rate should slip to 6.6% in 2016 from 6.9%. Its economic evolution should affect other nations and regions unevenly. Nations in emerging Asia could bear the brunt of spillovers, given their trade and financial links with China; commodity exporters may feel pain, too,” said Alberto Ades, Co-head of Global Economics Research and Head of Global Emerging Markets Fixed Income Strategy, BofA Merrill Lynch.
While India is expected to grow by 7.6% in 2016, the EEMEA region (emerging Europe, the Middle East and Africa) could rise by 2%. Latin America should contract by 0.2%, largely because of a 3.5% decline in fiscally-challenged Brazil. Russia’s economic growth should flatten in 2016 after contracting by 3.7% in 2015. If there are no major political surprises (and if commodities stabilize), investment should continue to recover, supported by growth in corporate profits and a deep decline in labor costs.
