2016 investment outlook: cycling forward
As investors venture boldly into 2016, the biggest news is turmoil in China, spilling over into markets worldwide. But beneath these headlines, the monetary policy cycle that has dominated financial markets in recent years is ebbing, allowing business, credit and valuation cycles to reassert their importance, says BlackRock Inc., the world’s largest asset manager1.
The BlackRock Investment Institute ( BII), which leverages the firm’s expertise across asset classes, client groups and regions, prefers stocks over bonds in this environment, particularly European and Japanese equities. Many U.S. stocks appear fully valued, the BII notes, while the collapse in oil and other commodity prices and China’s transition away from investment- led growth may continue to challenge commodity-linked markets such as Canada.
With that in mind, here are eight more takeaways for investors as they carefully navigate financial markets over the next 12 months.
TURN, TURN TURN: CYCLES ARE OUT OF SYNC
Monetary policy may take a back seat to other cycles f or the first time since the financial crisis. However, monetary policy cycles across the globe appear out of sync. With the Fed already tightening, the European Central Bank and the Bank of Japan are expected to keep policy very loose. Other central banks, i ncl uding Can- ada’s, continue to sit on the sidelines as they assess the effects of rising U.S. rates.
Global business cycles are diverging. Manufacturing is weak, while the service sector (which makes up more than two-thirds of economic activity in developed economies) is holding up. While developed markets are expanding, emerging market ( EM) economies are stalling due to China’s slowdown, with credit growth hitting the ceiling in many countries. BlackRock sees an extension of the business cycle as crucial for further gains in risk assets.
Valuations appear to have leapt ahead of the business cycle in many markets, especially in the U. S. With valuations no longer cheap and corporate profit margins under pressure in many markets, economic growth is needed to boost revenues. BlackRock expects little or no price appreciation in fixed income and only muted gains for most equity markets in 2016.
Credit and EM debt spreads have widened in the past year, mostly due to the commodity price implosion. The U.S. credit cycle appears to be nearing its end, with return dispersion and default risks rising. The eurozone looks like it has more room to run.
U. S. RECOVERY: A GRINDING ADVANCE
The U. S. economic expansion is following the script of a grinding advance after a banking crisis and likely has room to run. A lot is riding on the recovery as other economies struggle. BlackRock sees a gradual path to higher U.S. rates in 2016, but believes the market has priced in too few rate hikes given jobs, wage and inflation trends. Rising U. S. rates would also widen global monetary policy divergences.
CHINA’S ECONOMY: A MANAGEABLE DECELERATION
China has accounted for one- third of global growth since 2010, according to the International Monetary Fund. It’s no wonder the economic deceleration and shift to a consumer- driven economy are putting the brakes on the global business cycle. Both are part of a natural evolution, but pose structural challenges to EMs and commodity producers. BlackRock expects China to muddle through these challenges to a soft economic landing.
THE EUROZONE: A WEAK RECOVERY
The eurozone business cycle is in the early stages of slow- motion recovery, assisted by bank credit growth and a falling euro. Manufacturing gauges have been on an upswing since 2012, and the trade surplus has risen to record highs. The monetary policy cycle has moved into high gear with a negative deposit rate and quantitative easing until March 2017. BlackRock sees these signals as supportive of eurozone equities and corporate bonds.
EMERGING MARKET
ECONOMIES: A TEMPORARY LIFT
EM economies remain in a downturn due to dependence on China and the commodity price i mplosion. Cyclical factors such as an uptick in global growth and better trade balances due to currency depreciations could provide a lift to depressed EM equities — but only temporarily.
CRUDE OBSERVATIONS: THE
OIL PRICE PUZZLE
Crude’s c ol l a pse has dragged down even longterm inflation expectations. This is a conundrum for central banks, many of which were already struggling to meet their inflation targets. Now, low inflation expectations could encourage some to step harder on the monetary accelerator. The U. S. dollar’s rise has already led to some tightening in financial conditions. Further gains would intensify pressure on U. S. profits, commodity prices and EM currencies.
KNOWN UNKNOWNS: POLITICAL RISKS TO WATCH IN 2016
BlackRock sees political risks returning in 2016, with identified hot spots distributed across the globe. In the U. S., an upcoming presidential election continues to offer a wide field of candidates and a range of possible outcomes. The American election’s populist overtones, combined with scandals uncovering untoward corporate behaviour, raise the risk of a regulatory backlash. In Brazil, a political crisis stemming from a widespread corruption scandal may lead to possible debt downgrades. Europe will continue to face a refugee crisis, coupled with the threat of terrorist attacks. European stability may also be threatened by a possible “Brexit” with a United Kingdom referendum on remaining in the European Union occurring as early as June 2016 — but no later than the end of 2017. In the Middle East, threats of Islamic State terror will continue as government control over trouble spots and so- called “failed states” wanes. The war in Syria will continue to destabilize the region, while relations between Iran and the West will remain frosty.
LONG- TERM TRENDS: GLOBAL GROWTH AND A RETURN TO FUNDAMENTALS
Long- term trends such as aging populations, high debt loads and technological change are intersecting with short- term cycles. This means the high growth rates of the past may not return. The good news? BlackRock sees a modest pick- up in global growth, and a renewed investor focus on fundamentals.
1. Based on $ 4.52T in AUM as of 9/30/15.
This material is part of a series prepared by the BlackRock Investment Institute and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of December 2015 and may change as subsequent conditions vary. The information and opinions contained in this paper are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This paper may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this paper is at the sole discretion of the reader.
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