In­vestors gear up for chal­leng­ing times in 2016

Financial Mirror (Cyprus) - - FRONT PAGE -

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.

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