2015 will have been an important year for the global markets in several ways. First it marked transitions in key areas such as geopolitics, macroeconomics and liquidity. Second, markets prepared themselves for divergence in monetary policies worldwide. Global markets are slightly down (-0.9%) for the year in US$ with outperformers such as Japan (+8.4%), China (+5.7%) and the US - while emerging markets (-15.1%) and Europe (-2.8%) underperformed.
Looking forward to 2016, what are the key themes for the markets? An important point in our view is the rise of diverging mini-cycles in the global economy, overlaid by several key trends representing potentially strong sentiment influencers such as shifting geopolitics. Clearly liquidity, or shifts in liquidity, will continue to be crucial to asset price performance in 2016.
The context of tepid growth will most likely stay with us for many years. The combination of three substantial themes - such as climate change, demographics and the maturing of the emerging markets growth cycle - continues to be the essential framework to use as a backdrop to economic growth globally for the medium term. Ongoing structural adjustments and the impact of regulations stemming from the excess of the financial crisis are also contributing to a slow growth environment. This combined with relatively large output gaps and disruptive innovations all contribute to low inflation or meager pricing power for many industries. We should expect the emergence of “mini-cycles” where small changes can have a large impact on markets, sentiment and decision makers. Policy mistakes can also have a disproportionate impact in such an environment and tail risk will increase.
Headwinds and Tailwinds
Interestingly, economic divergence between various economic
powers - and the resulting actions they will commend - will deepen in 2016, bringing
us into uncharted territory. The multi-speed world that has developed has been
characterized by the departure from synchronized central bank policies and laid
the path for soft transitions in 2015. 2016 will not be as harmonious, as there
is more likelihood of opposing policies and/or differences in timing between
central banks for implementation of policy changes. Fragile economies (Europe,
Japan and China) will see more QE and administrative measures, while America
attempts to normalize before the end of an atypically extended business cycle
and a new political cycle. Even within a group of countries such as emerging
markets, fragmentation and divergence is becoming more apparent - as the case
for Russia and Brazil on one hand, and China or India on the other end shows.
Emerging markets private debt must be closely monitored as estimates show that
it has grown from 73% GDP in 2007 to 127% of GDP in 2014 (including shadow
banking). It is also plausible that the world is still overestimating China’s true
potential growth of 4 to 5%. As the
country finds the bumpy way to adjust officially to its new growth model, the
rest of the world might also continue to revise global growth estimates
downward in 2016.
This divergence intensification could bring volatility to
currencies and global markets and could create headwinds. A stronger dollar on the back of a US rate normalization
could result in headwinds for US growth. Liquidity issues, part of which stem
from regulatory changes, might surface faster than most expect. Volatility
could also be increased by geopolitical tensions around the Middle East, the
refugee crisis, climate change events, terrorism and continued political
polarization in Europe and the US.
Deflationary Growth Looking at growth and inflation for 2016, it is striking to see how the most promising pockets of growth around the world are inherently deflationary. The economic profile of some of the best innovations we are witnessing such as “sharing” (“Uber-like”), or more precisely, real-time resource management (for example the Industrial Internet- see “The Industrial Internet: An Underestimated Game Changer?” ) and the industry of “less” - such as what is needed to tackle climate change (see “COP21 – Paris Convergence on Climate Change: Politics versus Profits” ) are all about a better use of existing resources. Clearly as unemployment improves, potential wage pressure could build up somehow. Although this might be the case for the US to some extent- albeit not witnessed so far despite a 5% unemployment rate- we are far from it in other parts of the world given large unemployment levels.
Looking at tailwinds for 2016, low rates and more QE in some parts of the world will be positive for consumers and pockets of the market. European QE, to be as effective as it has been in the US, needs to be accompanied in our opinion with broad structural reforms - and not only in peripheral Europe. Core Europe also needs to be more flexible and a supporter of entrepreneurship and innovation. A weaker Euro will support European exports but exports to emerging markets might continue to see weak growth in 2016.
The US is doing well relative to the world, but trend data is not as strong as could be expected at this stage of this elongated business cycle in several areas such as productivity and unit labor costs. This again is an indication of mini-cycles and the low growth environment. Steps towards normalization of rates in the US are also positive, although we must carefully assess the path of rate increases beyond the first one. Markets might ponder on the scope for policy mistakes if the speed of rate increases turns out to be too slow or too fast.
While the US consumer, representing 15.5% of the world’s GDP, is proving wiser than in previous cycle with regard to savings (latest savings at a 3 year high), improving job reports should bode well to support spending in specific areas - although it is important to note that the trend for after-tax real household income has been negative. It is also important to take into account continued noticeable consumer shifts in wallet in the US, the largest single consumer force behind world growth, as consumption growth has been focused in a few key areas (see “US Consumers: Have the Past 20 Years Changed Anything?” ) with a noticeably prudent profile (pension, health care, savings) in light of recent years’ trauma and demographic trends.
Finding Pockets of Opportunities for Growth in this Environment Given the potential source of volatility discussed above for 2016, it will be increasingly important to invest in specific opportunities - as opposed to general benchmark and market allocation. Stock picking will be key.
“Less is more”: climate change related investment, energy efficiency, monitoring, personal efficiency
Industrial Internet revolution
Domestic/ Consumer Japan, China and USA. Few areas with pricing power. Discounters
Conclusion 2016 will see a continuation of the low-growth, low-rate environment we have experienced in 2015, which has been broadly supportive of markets. However, divergence and rising tail risk are bringing the Global Village to a new phase. The mini-cycles that are under way will take place in the context of deflationary growth and will be challenging for central bankers to manage - perhaps opening the door wider to policy mistakes. This also coincides with a time of potentially important political shifts (elections) in several countries, as well as rising global tensions, possibly triggering bouts of volatility that will offer opportunities for investors to get exposure to strong, medium-term themes.
In addition, markets in 2016 will possibly show an increase in short-term “technical” moves, possibly led by portfolios positioning shifts and disconnected from fundamentals. We witnessed some of this in the recent sudden surge in basic materials, oil & gas and commodity/capex-linked industrials in Europe and the US over the October-November 2015 period. The outperformance was led by the anticipation of central banks moves and not by fundamentals. We have little reason to believe that 2016 will be a turning point for these sectors in light of the previously cited tepid growth factors.
ABOUT THE AUTHORS
Simon Kelley Independent Contributor
Simon is a global consumer equity specialist. He started covering the sector as an analyst at JP Morgan. In 2004 he switched to the buy-side, firstly at Pictet Asset Management as a global consumer Sector head before becoming a hedge fund portfolio manager at Citadel, Millennium and Citi Principal Strategies. Most recently he was Global Consumer Portfolio Manager at PIMCO. Simon holds an undergraduate law degree, two post-graduate law degrees and an MBA from the University of Oxford. Simon is a qualified Barrister, (1994 call).
Virginie Maisonneuve Managing Director
Virginie is founder and Managing Director of Maisonneuve Global Advisors. Virginie’s background in asset management spans over 28 years and she served most recently as CIO-Equities, MD at PIMCO (London). Prior to this she worked as Head of global equities at Schroders (London), Co-CIO at Clay Finlay (New York) and held various senior portfolio management positions at State Street Research (San Francisco), Batterymarch (Boston) and Martin Currie (Scotland). She started her career as a consultant for the French Ministry of Foreign Affairs in Beijing (China).
Virginie has an MBA from ESLSCA (France) and a BA from Dauphine University (Mandarin Chinese). She also has a first degree diploma in Political Economy from People's University (Beijing, China) and is a CFA Charterholder.
Lucrecia Tam Independent Contributor Lucrecia was most recently a vice president and global Sector Specialist/ portfolio manager at PIMCO in London, focusing on industrials for the global growth equity strategies. Prior to joining PIMCO, Ms. Tam worked for Schroders Investment Management in London as a Global Sector Specialist for Industrials Prior to that, she was an analyst at Allianz Global Investors Capital in San Diego and an equity research analyst at Deutsche Bank Securities in New York. Ms. Tam has a Master of Science in Management from Boston University and Bachelor Science in Computer Science from Roosevelt University in Chicago.
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