Investors gear up for challenging times in 2016

The global economic landscape presents myriad opportunities to traders and investors. Already, history has been made with the first Federal Reserve rate hike in nine years. The 0.25% increase in interest rates now brings the Fed Funds Rate to 0.50%, with further upward momentum expected to drive the interest rates to 1% by the end of 2016. This has far reaching implications for the US economy, emerging market economies, and various asset categories. That the US economy has peaked, and is slowly retreating off of its highs is evident.

Investors are under no illusions about the impact of a Fed rate hike. The European Central Bank (ECB) has opted to decrease the deposit rate by 10-basis points to -0.30%, and increase the period of asset repurchases for an additional 6 months valued at EUR 60 bln per month. This divergence in central bank policy is as clear as the distinction between day and night. Strangely, the actions taken by the ECB’s Mario Draghi ad the opposite effect on the euro: it rallied after analysts were convinced that the ECB took less dramatic action than it was capable of taking. The double-whammy that the euro was expected to endure simply did not come to pass: The Fed interest-rate hike did not cause a massive depreciation in the euro either.

The U.S. was the first country to adopt quantitative tightening after multiple years of quantitative easing. Everyone remains convinced that deflation is the numberone bugbear in the global economy. However, even the most obvious signs of deflation – plunging crude oil prices – have resulted in increased savings and increased retail expenditure by consumers. This is proving to be an important hedge against deflation. Whether or not the United Kingdom will follow suit is anyone’s guess. However, analysts at Banc De Binary expect the Bank of England to seriously consider raising interest rates from their current level of 0.50% by the end of 2016.

But the big problem remains China. There is growing concern that the Chinese economic meltdown will result in a further deepening of problems in emerging market economies. This is already evident in plunging commodity prices, falling revenues, job losses, the shuttering of mines, and so forth. The currencies of emerging market countries remain precariously balanced, and their exchange rates against the USD have fallen to all-time lows. This is particularly true of the South African Rand, the Brazilian real, the Turkish lira, the Venezuelan Bolívar and others.

The FTSE 100 index has taken a huge hit on the back of the commodity price plunge, as evidenced by BHP Billiton, Glencore, Anglo American, Rio Tinto, et al.

Typically, rising interest rates are a bad omen for bond markets. However, we may see investors switching to value investing en masse. The 2016 presidential election is one of the most hotly anticipated events in recent history. Not only that, Britain will be making a decision via the referendum as to whether it wishes to remain a part of the European Union. The so-called Brexit is an important topic that has pundits deeply concerned about the unity of the Eurozone.

While it is foolhardy to suggest that Donald Trump will become the next US president, the implications of such an option need to be considered. What is more likely is that if Donald Trump is elected as the GOP candidate, he may very well hand the election to the Democrats and Hillary Clinton. He is seen as a polarising force with a very limited appeal in US political circles.

In the U.K., there are many concerns about pensions, the property market and so forth. Presently, the property market in London is highly overvalued, and there is concern among many in the real estate sector that the property bubble will have to burst in order for accurate pricing to come to pass. The good news for those who are measuring the performance of the US economy versus the EU economy is that the gap between them is closing. The US economy is growing at a rate of up to 2.5% and the EU economy is growing at a rate of 1.8% per annum. A caveat is in order though: various credit ratings agencies are expecting the US economy to undergo a recession within the next two year period.

When it comes to anticipating the strength of the US dollar moving forward, it is difficult to say where we are on the cycle at present. Typically, a rate hike results in an appreciation of the USD and nobody can really foresee a weakening of the dollar at this point in time. People who are concerned about China weakness or general emerging market currency weakness are generally long on the USD and this is precisely what is happening.

There are analysts who believe that the Fed acted to give itself wiggle room so that when the inevitable downturn in the economy does take place they will have the option of cutting interest rates once again.

The problems in the US are not in the services sector, but in the manufacturing sector. This is clearly evident with manufacturing PMI data. The data tends to support the reality that as manufacturing PMI decreases, so too does services – services have very rarely, if ever dragged up the manufacturing sector. At present, corporate confidence and consumer confidence in the US is really high, and failing a geopolitical shock to the US economy this is unlikely to change. Jobs growth has been robust in 2015 and this has helped to bring about a Fed decision in favour of a rate hike.

China is the proverbial elephant in the room, but this time around everyone is talking about China. The IMF expects China’s GDP to grow at 6% for 2016. Many analysts are not as concerned about China as they are about a recession in the US. The Chinese government retains tremendous control over the economy and it has substantial scope to stabilise markets if indeed a recession were to take place. The only problem that we saw in 2015 with China was government interference in the equities markets to try and stabilise them, which only resulted in a $5 trln equities rout overall. The corporate sector in China is heavily indebted, with massive borrowings plaguing the growth prospects of the equities markets. A rebalancing certainly needs to take place. The big change in emerging market economies will occur when China moves towards a services-oriented economy as opposed to a production-oriented economy.

A long and drawn-out process of adjustment is going to take place in China, but the good news is this is already underway. There is tremendous excess capacity available in multiple energy, metals and other sectors that was otherwise consumed by China.

Emerging markets are going to feel the pinch in 2016, and many of these commodities will be dumped on the markets en masse at prices that will depress revenues and profitability.

Back in the US, when it comes to commodity prices, cheap oil has increased the personal disposable incomes of consumers, with much of the available funding going into savings and retail expenditure. Restaurant revenues have been going through the roof, as people simply don’t have enough money to move out of rental accommodations and buy their own properties so they are spending their excess income on entertainment and leisure. Many of these trends will continue moving forward, and it’s difficult to pinpoint with any certainty what outcomes will impact on markets at what time.