As the New Year has gotten off to a dramatic start, we anticipate 2016 to be similar to last year as fundamental conditions remain largely unchanged. Our most probable scenario for 2016 is substandard global GDP growth, modest advances for most key stock markets, very low returns for bonds and money market funds, and a continuation of challenging conditions for commodities, including oil. We have noted, however, significant divergences of professional opinion, including sharply negative views, regarding the prospects of the world’s major economic and financial markets. The focus will be on U.S. Federal Reserve policy, the dollar, the ability of Chinese policy makers to bolster their economy, commodity prices, and the plight of developing countries. A surprising negative development in any of these factors could slow U.S. economic and profit growth, but we think a full blown recession and bear market is unlikely. Success in equity investing in 2016 will continue to depend on identifying companies able to sustain attractive growth in a difficult macroeconomic environment and resisting the temptation to bottom-fish troubled markets and industry sectors.
We project global GDP growth for 2016 to be about 2.9%, which is slightly above our estimate of 2.7% in 2015. The major advanced economies should expand modestly: we project 2.5% GDP growth in the U.S. with a possible upside surprise, a slight improvement in the Euro area and Japan to 1-2% in response to accommodative central bank policies, stabilized economic conditions in China around 6%, further strengthening in India to 7.5%, and continued recessions in the commodity-exporting emerging countries.
The U.S. economy could surprise on the upside. On the positive side, further employment gains, low energy prices, and a persistent housing recovery will boost consumer confidence and spending. The recent budget agreement in Washington will add a measure of fiscal stimulus. Further, many of the structural impediments to growth arising from 2008-2009 will continue to erode.
We expect the S&P 500 Index to rise 7-10% in 2016. We view the U.S. market to be fully but not overvalued and expect the S&P 500 Index to rise in-line with corporate profit growth, which we project will be 7-9%. That is, we think the correlation between market performance and profit growth in 2015 will extend to 2016. Stock prices will continue to be buttressed by unattractive prospects for bonds and money market funds and continued high levels of M&A activity and stock buybacks.
The U.S. market will likely experience increased volatility in response to news regarding key market influences. We advise investors to maintain a longer-term perspective and not be overly influenced by short-term developments.
- We expect the Federal Reserve to gradually raise rates to 1.00 – 1.25% by year end, which we do not think will create economic distress or prolonged market turmoil. Possible threats are a resurgence of inflation that might prompt the Federal Reserve to adopt a more aggressive rate hike policy or, conversely, indications that the economy is too fragile to weather even this modest set of rate increases.
- Contrary to consensus opinion, we think the dollar will stabilize against a basket of currencies at the current level. The dollar rose 25% from mid-2014 to March 2015 but has since traded in a narrow range. We expect a relatively stable dollar through 2016 based on the determination of the IMF and the Federal Reserve to avoid the negatives resulting from an upward spiral. A sharp rise in the dollar would damage the currencies, economies, and markets of commodity exporting countries, and inflict more pain on the U.S. energy industry, reduce the profits of U.S. corporate exporters, and jeopardize our 7-9% corporate profit forecast.
- A widespread negative view is that the Chinese economy is in free-fall leading to a hard landing and clumsy attempts by policymakers to manage the slowdown will be ineffectual. The investors that maintain this view fear that China will export recession to other countries, which in turn will possibly foment a U.S. recession. The global stock market slide over the first four trading sessions of 2016 was dominated by events in China that seemed to justify the pessimism. We maintain our positive view expressed in past outlooks and blogs that the Chinese economy is successfully undergoing a transition from exports and investment to consumption, and we forecast 2016 GDP growth at about 6.0%. The policy makers, including the People’s Bank of China, clearly are determined to avoid a further slide in growth, and we believe they have the tools to prop up the economy if necessary.
- We think that the five-year decline in commodity prices will extend through 2016. A significant rise in the price of oil is unlikely as long as Saudi Arabia and OPEC keep the spigots open and Iran comes back online, with U.S. producers poised to increase production as soon as wells become profitable. On the other hand, some investors fear that if commodity prices fell sharply lower, it would portend a slowdown in global demand. They believe that the economic benefit from cheaper costs to consumers and businesses would be more than offset by job cuts and lower investment from resources sector.
Despite challenging economic headwinds confronting many international economies, we think there are pockets of opportunity and companies of considerable potential which are attractive to investors.
- The leading advanced international economies of Euro area and Japan should build on their 2015 equity market progress. Although widely accepted benchmarks for international stocks were negative in 2015, there were local currency stock market gains of 8.2% in Japan, 10.8% in Germany, 10.0% in France, and double-digit advances in many other European countries. We anticipate a combination of economic pickup and further accommodative stimulus by the Bank of Japan and the European Central Bank to provide a promising outlook for 2016.
- Demographic trends and the growing middle-class in Asia provide significant opportunities for equity investors. Many of the economies of this area are troubled by the slowdown in China and decline in commodity prices, but the rise of middle-classes supporting consumption goes on, especially in China and India. Multinational corporations providing goods and services to this middle-class can maintain attractive revenue and profit growth despite macro headwinds.
- Equity investing in the heavily damaged markets of the commodity-exporting emerging countries offers more risk than reward, at least for the first half of the year. Although most equity markets and company stocks in this category suffered in 2015 and their valuations seem attractive, we prefer to see a significant improvement in conditions to justify investments.
The three-decade long decline in bonds yields is probably over. The prospect of a U.S. economic surprise on the upside, the probability of an uptick in inflation, and the advent of the Fed rate hiking process should result in a modest rise in bond yields. The consequence is the likelihood that investment grade tax-exempt and corporate debt with maturities of less than ten years will return less than 2.5%. There remains the possibility of negative total returns if inflation rises, the Fed becomes more aggressive, and current bond investors head for the exit.
We thank our many clients for their loyalty and partnership and we wish all of our readers a prosperous 2016.