A world of low numbers
Financial markets got off to a poor start in January, as investors quickly priced in further worries about events in China and the Middle East. In recent years, a pro-equity stance was the correct strategy; any sell-off on growth concerns was seen as a tactical buying opportunity, on the grounds that central banks would do enough to keep the world economy expanding. 2015 was different though – global equity returns were broadly flat after including dividends. We expect similar in 2016: modest total returns for the patient investor, accompanied by sharp market cycles as economic or political shocks appear. All in all this remains a world of low numbers, whether in terms of GDP, inflation, interest rates, bond or dividend yields.
While bad news can dominate short term trading, what four factors should investors look at to determine when and how to invest in 2016? The first such driver would be whether consumer spending continues to hold up rather well; for example global auto sales in 2015 were back to pre-recession levels. As recent business surveys demonstrate, the strength of household consumption and indeed business services generally contrasts with weaker industrial production and trade data. The backdrop for consumption is good while the labour market is improving, commodity prices are low, and credit more available. One important difference going into 2016 will be more supportive fiscal policy; EU governments are moderately relaxing their debt targets, while fiscal spending in China is growing its fastest since 2012.
A third driver will be the extent of monetary tightening in the US, which could either be via interest rates or the US dollar. The pace of wages growth in particular, labour market tightness in general, will be key for the Federal Reserve. The danger is a repeat of 1994; history suggests that financial markets become more volatile when monetary policy or general financial conditions diverge noticeably between countries. Policy tightening by the US contrasts with easing in China, the Eurozone and Japan where growth and inflation still remain below target.
Corporate profits growth will be a final factor to determine how much risk to hold in portfolios. The positive scenario for 2016 would be top line sales growth beats expectations, for example on the back of upside surprises to nominal GDP reports from the US, China and Europe. In effect the global consumer begins to spend their income gains, and the manufacturing sector recovers from its current weakness. For US firms, a stable US dollar would also help. Conversely, triggers for a more negative outcome would include a sharper appreciation of the US dollar, a larger rise in borrowing costs, worsening unit labour costs or more pressures on pricing power. The recent earnings season showed share prices react adversely to earnings disappointments.
Our House View was cautious at the start of 2016, with exposure limited to European equity, some corporate bond markets, and commercial real estate, while we await better entry points.
Andrew Milligan, Head of Global Strategy, Standard Life Investments