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.
