Monday, January 4, 2016
Welcome to 2016, and of course a very Happy New Year to all my blog readers! As usual at this time of year, I like to reflect on the events of 2015 and what 2016 might bring in terms of the global macroeconomy and the capital markets in general.
So let’s start our global tour by first looking at the US. 2 factors were surprising in 2015: firstly the continuing fall in oil prices down to the mid-$30s – of course the fall started in 2014 but it has continued to fall as OPEC’s indecision has weighed on the oil markets; and secondly, the lack of any Fed tightening until December, despite the fact that there were expectations that rates would rise much earlier in the year. All this suggests that growth in the US will, if anything, accelerate in 2016, and it implies that the US economy will continue to perform well as the country settles into the later part of the business cycle. Although some regard 2015 as a lackluster year, the markets are really not a good reflection of the surprising resilience of the US consumer, who is not only saving more, but also is spending more, but notably on different types of products than previously. In particular, the tech sector still has strong potential growth given that this remains a comparative advantage for the US, and the housing sector continues to perform well, as the demand for housing is still masked by unreasonably strict credit conditions and the fact that ageing boomers are living longer and therefore inheritances are being delayed to the younger generations. The Biotech sector has had a miserable year in terms of stockmarket performance, and this will likely continue and if anything worsen until the US elections are over, as drug pricing remains a politically divisive issue.
In terms of the increase in interest rates, the Fed has made it clear that it will likely hike rates 4 times next year, which, as I stated in my last blog, likely reflects the fact that the Fed wants to normalize and realizes it has fallen behind the curve in terms of adjusting rates to appropriate rates ahead of the next downturn in the economy. In other words, the Fed has prioritized rate hikes over withdrawal of quantitative easing (QE), which still leaves a lot of extra funds sloshing around the financial system. Most financial market economists have forecast fewer rate hikes, and therefore little likelihood that the US dollar will further strengthen, but I think that this is a mistaken view – the Fed knows that January 1st sees a raft of increases in minimum wages across the country, and so wage pressures are picking up, which coupled with extremely loose monetary policy implies that inflation pressures will likely build in the US economy, which will justify the rate increases, plus the fact that the QE will still largely be in place will also continue to act as an economic stimulus. The wild card here though is the US dollar, which could appreciate, capping any inflationary pressure due to import price pass through to items like clothing and retail items, and also putting further dents in export performance by US multinationals. Any fall in the US dollar would therefore work in the opposite direction – to likely stimulate exports, adding to economic growth, but raising import prices thereby leading to greater certainty regarding Fed interest rate hikes. Another potential factor stimulating the US economy will be largely dependent on Congress going forward – the Trans-Pacific Partnership or TPP. If this does get passed by Congress and signed into law, the impact could be significant in the latter part of 2016.
Next, let’s move on to Europe. For 2015 Europe has had a good year in economic terms, with the exception of a few countries (for example Greece and Portugal), but near all-things non-economic in Europe have not gone according to plan in 2015. The reason for the good news is largely down to the ECB and Mario Draghi’s “whatever it takes” QE, which has spurred stronger economic growth in the euro area core and periphery, giving stockmarkets such as Germany’s and Ireland’s a pretty good year. The depreciation of the euro appears to have had little effect on import prices, largely because any increase in non-oil import prices has been more than offset by the (much) lower oil and other commodity prices. This is the reason that I have heard many economic commentators say that Europe is now “mid-cycle” compared to the US’s “late-cycle” position, but I think that although Europe lags behind the US in terms of business cycles, there is an “international business cycle” effect which does tend to tie Europe closely to the US business cycle – in other words, I think that Europe, although it has struggled to record significant economic growth rates, still only lags marginally behind the US in terms of its (natural) business cycle. Given the ECB’s continuing stimulus through QE, the less fiscally profligate economies in Europe will continue to do well in 2016. On the Transatlantic Trade and Investment Partnership (T-TIP) with the US, I think this will get put on hold in 2016, given the Presidential elections.
One side note on Europe here concerns the UK in 2016. In the UK, there is a referendum planned on continuing membership of the European Union (EU) in June, in which Prime Minister David Cameron will make the case for sticking with the EU (but continuing to stay out of the euro). There are various forces in the UK now aligned against continuing membership of the EU – that is one reason why the UK stockmarket is down for 2015 when most EU stockmarkets are up over the same year. Obviously the outcome of this referendum on the EU will colour the performance of the UK economy and of the UK stockmarket in 2016.
The Japanese economy saw continued signs of response from the QE being tried there by Prime Minister Shinzo Abe, but the US dollar’s strength coupled with the yen’s weakness meant that unhedged returns were muted, despite the fact that the Nikkei was up by over 9% last year. Given the continuance of QE in Japan and Abe’s reforms, Japanese growth should be positive again, and that should lead to further stockmarket gains, although the direction of the currency is less certain in 2016, as the yen is now seen as more of a “safe haven” currency, and could be buoyed by inflows from China.
Turning to China, although markets there were positive over the previous year (up over 9%), the continuing devaluation of the yuan will sap confidence over “directed” economic policy. Furthermore, as global growth will be under par as a whole, China will continue to slow, and this will be reinforced by the collapse in Chinese investment. I would expect the Chinese stockmarket could be down significantly in 2016, particularly if the Chinese government does not stimulate the economy. In India, if Modi can continue to push through meaningful reforms, then the stockmarket could be one of the better performers in 2016.
Other than the major economies already covered above, I believe that unless there is an escalation conflict in the Middle East, oil prices will continue to be extremely low in the first part of 2016 and may move even lower than the high $30s, but in the second half of the year, there will be some rebound in prices as bankruptcies in the US leads to less supply on world markets. In terms of commodity prices, they will continue to be weak into the first half of 2016, but once again, there could be some rebound in the second half as there is “overshooting” which leads to bankruptcies in this sector.
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