We expect global economic growth to gradually strengthen over the course of 2016 as consumption in the developed markets picks up, especially in the US, and as China and other emerging economies stabilise. However, growth is likely to stay below longer-term trend levels for a number of cyclical and structural reasons. These include the ongoing overhang of debt, adverse demographics in most of the major economies, the rebalancing of China’s economy, an excessive global savings rate and monetary policy exhaustion. Meanwhile, inflation is likely to remain contained, enabling central banks to keep policy accommodative and interest rates very low, even in the US.
We are cognisant that there are risks to this base-case scenario. In addition to the Fed’s decisions and developments in China, potential key macro drivers include factors such as a stabilisation in oil and other commodity prices, an easing of global deflationary pressures, the limits of monetary policy divergence being reached and elevated geopolitical concerns. While deflationary pressures appear to be dominating at present and economic activity could again disappoint, there is also a chance that growth and inflation could surprise on the upside, especially in the US. This could force the Fed to raise rates quicker than the market currently expects (in line with the FOMC’s current expectations).
Given our base case, we expect that equities will perform relatively well, since valuations in most markets are reasonable and earnings growth should support share prices. However, with global economic fortunes and policy trends diverging, and regional market valuations contrasting, stock selection will again be a key to success (as it was in 2015). The challenge for most companies continues to be how to maximise revenue and profit growth while maintaining margins against a backdrop of modest growth and inflation.
Generally, we believe that the developed markets will again outperform; we have a preference for Japanese and US equities, while Europe could also deliver attractive returns. The Emerging Markets continue to face a number of threats and are likely to experience mixed fortunes, but will eventually provide a good buying opportunity.
Turning to bonds, credit markets (and selective high yield issues in particular) look better value after the recent sell-off. The macroeconomic outlook, as explained above, is somewhat favourable, although the credit cycle is becoming more advanced in a number of developed economies, most notably the US, and the threats of growth disappointments and additional monetary policy tightening continue to weigh. Furthermore, liquidity is among our key risk considerations. As such, security selection will be very important in credit, as it will be in equities. In the meantime, core government bonds (including UK gilts and US treasuries) will continue to provide a hedge against weak growth or an escalation in deflationary pressures, despite the relatively low yields on offer.
We will continue to monitor currency movements very closely, as the US dollar’s strength and a change in foreign exchange policy by the Chinese authorities have both been key drivers of sentiment and markets of late. Our view is that the dollar will move higher on a trade-weighted basis during 2016, although further gains will most likely occur versus emerging market currencies rather than the euro or yen. Sterling should also stay reasonably strong against most currencies, although the impending debate about a possible ‘Brexit’ will likely pose a risk as the year develops. Meanwhile, we expect a modest additional depreciation of the Chinese renminbi, on a trade-weighted basis; hopefully this will take place very gradually as a sudden move could unsettle markets again.
After a challenging and difficult 2015, we expect more of the same in 2016. In general terms, returns will likely be alpha driven (i.e. stock specific) rather than beta driven (market moves), although asset class, market and currency selections will be important. Ultimately, improving macroeconomic and corporate profit outlooks will create investment opportunities across all asset classes. However, we are aware of the risks and will remain vigilant and ready to change strategy quickly if necessary, as always.
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