2016 – a year of contrasts
Although global growth should be slightly higher than in 2015, we are still likely to see significant contrast between the advanced economies, where the recovery will continue, and the emerging market economies, which will be grappling with a less supportive international environment. Low interest rates make it risky to buy government bonds – as long as the markets haven’t fully priced in the normalisation of US monetary policy under way. At the same time, higher company profits should continue to buoy eurozone equities.
A favourable environment for developed countries
World: contrasting trends
In 2016, we can expect to see further contrast between the advanced economies, where the recovery will continue, and the emerging market economies, which will still be grappling with a less supportive international environment. Commodity prices are unlikely to bounce back this year. Not only is the oil market plagued with persistent oversupply, but China’s transition to a new growth model will keep metal prices down. There will also be a full political agenda in 2016, with ample geopolitical tension to generate volatility. Yet, while global growth is unlikely to pick up significantly, it won’t take a turn for the worse either.
United States: further rate hikes in the pipeline
A number of influential factors that impacted negatively the economy like lower government spending are fading, and the current upturn in construction should provide a boost to the economy. The strong dollar and falling oil prices will probably also have less impact than before, but because consumers have not yet taken full advantage of the resulting gains so far , they are likely to go on spending. The US economy can therefore look forward to solid growth (in the vicinity of 2.5%) and enough job creations to warrant additional interest rate hikes by the Fed.
Eurozone: ongoing recovery
The ECB’s highly accommodative monetary policy should continue to work its way through the system as lending resumes. At the same time, lower oil prices and rising employment should keep consumer spending up. The only cloud on the horizon is political risk, with Spain and Portugal as notable trouble-spots. Luckily, ECB asset purchases should be more than adequate to prevent any sharp increase in spreads.
Japan: good news after a weak spell
Japan went through a soft patch in mid-2015, but the upward revision to the third-quarter GDP growth rate indicates that the economy has avoided a technical recession. But while growth has yet to accelerate, the labour market has continued to tighten, and as rising wages energise consumer spending, the economy can be expected to gradually pick up steam. Japan’s export numbers have also been improving since the summer, which is encouraging news.
China: a soft landing
The slowdown under way in residential construction is likely to exert downward pressure on growth this year. The authorities, however, are using the leeway available to them to avoid a hard landing. In our view, the fall in the renminbi against the dollar has little to do with concern over Chinese GDP growth; it instead reflects the move to a new exchange rate policy, with the central bank now managing the renminbi against a basket of currencies. To sustain economic activity, further monetary easing will be required.
Emerging markets: growth differentials
Growth rates can be expected to vary widely from one emerging market economy to another, depending on their exposure to commodity prices. Asia’s emerging markets are well-positioned to leverage the current situation, and they also have room to stimulate domestic demand. Meanwhile, it would be nice to see Russia doing a bit better, particularly as Brazil is still very much on shaky ground. Although external vulnerability is an issue for only a few countries, tougher borrowing conditions and mounting corporate debt highlight the need for caution.
overweighting equities, above all eurozone equities
Bond markets hanging on the Fed’s next moves
The normalisation of US monetary policy under way has yet to be priced in fully by the bond markets. It can therefore be expected to push up long-term yields in the US – and elsewhere by contagion.
In Europe’s high-yield space, ECB monetary policy and the economic upturn in the region should keep the market humming.
Spreads on emerging market debt have already widened, but that debt will likely show greater sensitivity to tightening by the Fed.
We anticipate a slight additional depreciation in the euro against the dollar.
More selectivity in stock picking
Due to concerns about growth, equity markets show high volatility, but it is worth recalling that equity market valuations are still closer to normal than those of any other asset class. This tells us that we would do well to set our sights on markets with reasonable valuation levels and that still have room for higher earnings – in other words, the European and Japanese markets. While low prices do make emerging market equities attractive, the risks are too high for now.
Does the market underestimates the risk of higher inflation in advanced countries?
Most investors are betting on an extremely gradual rise in inflation from its current low level, so they get along with rock-bottom interest rates. Inflation swaps suggest that inflation will stay below 2% for another ten years or so in the euro area and for nearly five years in the US. Falling oil prices are a key contributor to that trend, but their impact should lessen once the base effect is no longer a factor. Declining jobless rates in the advanced economies will lead sooner or later to rising wages, which will translate into higher inflation. In the United States, that could happen as early as this year. When it does, we may well be in for a stiff hike in interest rates.
What to track in the coming weeks?
In the weeks to come, the markets will be keeping a close watch on oil price fluctuations, economic indicators in China and any announcements by the world’s central banks, first and foremost by the Fed and the ECB in late January. It will also be important to track political trends on the eurozone’s periphery and in a number of major emerging market economies. In March, the Chinese authorities will be unveiling the details of their five-year plan, including the quantitative targets for this year.
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