Outlook 2016: Increasing divergence may yield opportunity (Archived)
BNY Mellon Investment Management believes that great minds don’t always think alike, especially when it comes to the challenging business of looking into the future. We asked specialists from several of BNY Mellon’s investment boutiques what investors may expect from financial markets in 2016.
What is your outlook for 2016 and what assumptions do you base it on?
Peter Hensman, global strategist at Newton: “I expect a challenging year for risk assets as nominal growth rates remain subdued and market volatility rises. Those conditions will increase the need for selectivity in stock selection with a focus on sectors and companies that have balance sheet flexibility and the ability to reduce their costs bases.”
Chris Barris, global head of high yield at Alcentra: “The US will experience modest economic growth, slightly above 2% and consumer spending will drive much of that growth. We expect oil prices to remain around US$50 per barrel and the dollar to remain roughly at its current exchange rate with the euro.”
Todd Wakefield, portfolio manager with The Boston Company: “I don’t expect an economic recession, though we may have a corporate profit recession. I expect increased government spending to help the US grow by around 2%, while corporate profits stay flat and the Fed starts to move off its zero interest rate policy. I expect stimulus programs in China to produce a soft landing there.”
Sinead Colton, head of investment strategy at Mellon Capital: “We expect continued US growth. In Europe, we expect ongoing expansionary policy from the ECB and a weaker euro to produce stronger growth in the Eurozone. In Asia, we expect further stimulus from the Bank of Japan, a continued slowing in Chinese growth, and ongoing challenges for emerging markets."
Rebecca Braeu, director of sovereign research at Standish: “We expect global growth to pick up from 3.1% to 3.3%. US growth will be led by consumer spending and investment in housing. European Central Bank policy will support growth in Europe, while growth in China will continue to slow moving into next year.”
Cliff Corso, North America CEO of Insight Investment: “US output remains below its potential, and we expect growth in 2016. That said, corporate debt levels have become worrying and we will continue to watch them. We expect several Fed rate hikes, moderately higher rates across the curve, and tighter corporate spreads. We also expect the dollar to strengthen moderately, Europe to accelerate, and China to slow in a well-managed, controlled fashion. These conditions should be positive for risk assets, though there will continue to be bouts of volatility.”
What is your outlook for the asset class that you specialise in?
Hensman: “I expect a challenging equity environment, and expect risk to underperform in fixed income.”
Barris: "For 2016, we expect mid single digit returns in the US and Euro HY markets, though commodity pricing could drive major variances from that target. For loans, we are anticipating a similar return profile but with less volatility."
Wakefield: “I expect small cap equity returns to be below the historical average. Earnings estimates are too high and profit margins have peaked.”
Colton: “For equities, we are currently positive on core Eurozone and Japan, and are negative on the UK. We are moderately positive about selective developed government bond markets, but are mindful of central bank policy actions.”
Braeu: “We expect the structural slowdown in China and across Asia and easing on the part of the ECB and Japan to create a strong backdrop for fixed income. In the US, gradual rate hikes and a continuing decent-sized economic expansion will continue to support spreads.”
Corso: “We expect corporate bond spreads to tighten as is the norm in hiking cycles. Given rising leverage at corporations, we find the protection of asset-backed securities attractive. We expect rates to rise in a manageable fashion.”
What do you expect US monetary policy to look like in 2016?
Hensman: “The Fed may have to reverse course later in 2016 by undoing earlier rate hikes and the federal funds rate may end next year where it is now.”
Barris: “I expect the Fed to remain prudent and cautious yet pragmatic over the next year. I think the Fed has capacity for three rate hikes between now and the end of next year with the Fed funds rate rising by 75 basis points from current levels by the end of 2016.”
Colton: “The way in which the Fed explains its actions as it pursues normalization will also influence how markets react to the now unfamiliar experience of higher rate, given this will be the first Fed rate hike in many years. We don’t view policy normalization as being too disruptive to markets as long as the Fed communicates clearly that, as expected, they plan to tighten policy at a very measured pace.”
Whatever the pace and extent of US policy normalisation, what does it's divergence from other economies mean for the strategies you manage?
Braeu: “It means potential opportunity in fixed income. We look at relative value and policy rate opportunities. In Europe, we see economies growing above potential, the ECB easing, lax national level budgets and some fiscal easing in response to the migrant crisis. That makes European rates and shorting the currency attractive on a relative basis.”
Colton: “We’re seeing a lot more divergence across economies, central bank policy, and growth rates, and that creates significant opportunities within many asset classes and currencies. We think the US dollar will be supported by Fed tightening, while further ECB policy loosening will weigh on the euro but support core Eurozone equities.”
Wakefield: “US equities may offer different opportunities than they have in recent years. Some areas of the equity market including companies with government contracts such as military and road construction contractors may do better in 2016 than those of companies that have benefitted in recent years from quantitative easing.”
All of our managers agree that forecasting is an inexact science but they acknowledge there are unknowns and risks to their forecasts. They recognise the unwinding of quantitative easing in the US is an unprecedented event that may play out in unexpected ways.
When asked what they felt would be the main drivers of growth in the year ahead, Newton’s Hensman says economies and sectors that benefit from positive elasticity of demand as he expects pricing to remain soft; Barris on the other hand believes consumer and consumer spending will be a main source of growth in 2016. TBCAM’s Wakefield says US fiscal spending in the US will be a growth driver and he expects China’s stimulus will cause a soft landing (at least for a year) in China; Standish’ Braeu says she expects that in the US, growth will be driven by the consumer and residential investment.
Meanwhile the managers and economists believe one of the biggest catalysts or ‘disrupters’ for markets in 2016 could be the US dollar, China’s stimulus measures and the price of oil. Insight’s Corso adds: “I would watch the dollar as should it rally too hard on policy divergence that could disrupt Fed hikes and earnings at global companies while weighing on US exports. The dollar cannot strengthen too much.”
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