2016 Outlook
HAPPY NEW YEAR’S EVE!
As each tick of the clock closes in on forever putting this year into the history books, I hope you have many pleasant memories when reflecting on 2015. With the start of the new year just hours away, I am happy to share some insights and ideas for 2016.
Wishing you a Happy & Healthy New Year!
John
While considering what might be in store for 2016, I took a look back at what I expected in 2015. It was a long list. In my “15 for ’15…” outlook list, most unfolded as envisioned. “Vulnerable to volatility,” the last of the list of 15 for ’15, might have best captured the year. At times the stock market’s swings were so wide and fast, it was violently volatile. Speaking to the market’s extreme price movement and nearly flat finish for the year, some analysts have called 2015’s stock market “violently flat.”
US Stock Market: There are myriad issues to contemplate when trying to divine the future, and perhaps more than normal with sites set on 2016’s market outlook. The focus of the stock market heading into 2016 was the Federal Reserve’s initiation of its interest rate policy. That will likely continue throughout the year. While I do not expect the Fed’s work finished with a “one and done” rate increase lift-off on December 16, I don’t expect a fast rate-hiking cycle., either. A slow cycle policy for interest rate increases in 2016 would be bullish for the US stock market. Research shows the S&P 500 rose an average 10.8% in the 12 months following the start of a slow rate-hiking cycle. It fell 2.7% the year after fast rate increases. The S&P 500’s bull run that kicked off about 82 months ago has jumped 200% from its March 2009 low. As the third longest uptrend since 1932, it surpasses the average bull market gain of 138%. For the run to continue in 2016, more than a slow rate-hike cycle is needed. Earnings will be a needed catalyst. The
market’s risk in 2016 is in the earnings, in my opinion. Earnings growth has stalled for almost a year. For 2016, analyst’s consensus is projecting earnings gains of 7.5% and revenue growth of 4.3%. The market is narrow and sustained upward price momentum is absent. While stocks have been going up for a long time, expect a modest gain for 2016 after this year’s pause. Using this equation to predict future stock market gains: GDP growth + dividends + inflation, 2016’s market would likely deliver a 5% – 6% return. This would beat back-to-back year’s of treading water, which the market could do next year. Back to corporate earnings…an upside surprise in earnings would provide upside to the market’s return in 2016.
market’s risk in 2016 is in the earnings, in my opinion. Earnings growth has stalled for almost a year. For 2016, analyst’s consensus is projecting earnings gains of 7.5% and revenue growth of 4.3%. The market is narrow and sustained upward price momentum is absent. While stocks have been going up for a long time, expect a modest gain for 2016 after this year’s pause. Using this equation to predict future stock market gains: GDP growth + dividends + inflation, 2016’s market would likely deliver a 5% – 6% return. This would beat back-to-back year’s of treading water, which the market could do next year. Back to corporate earnings…an upside surprise in earnings would provide upside to the market’s return in 2016.
US Economy: The U.S. economy is likely to deliver its 11th straight year of sub-3% Gross Domestic Product (GDP) growth in 2016, the longest such stretch since World War II. Typically, as the consumer goes – so goes the US economy, measured by GDP. Consumer spending accounts for roughly 70% of US annual GDP. Recent consumer spending trends should bode well for the US economy in 2016. This year’s big increase in the holiday season’s retail sales over last year shows consumers may be entering the new year with an appetite to spend. Still relatively low interest rates, more jobs and still low energy prices should continue to help consumers do their part to support the economy next year. I expect full 2016 GDP of 2%-2.5%. Most of that thanks to the consumer. The other components of GDP, government and business spending, are expected to make only a limited contribution to 2016’s US GDP.
Interest Rates: As mentioned above, the US stock market (and perhaps all others) approached the close of this year with a focus on interest rates and will enter 2016 with eyes still wide open on Fed watch. Much of the push behind the bull market since 2009 was done by the Fed’s unprecedented easy-money policies, namely “near- zero” interest rates. Now that the US Federal Reserve has embarked on its path to interest rate “normalization,” additional hikes will come in 2016. I am of the camp expecting at least one more, and only in 0.25% increments. Fed chairwoman Yellen, at least in 2016, might only impose additional rate hikes if the market’s and economy respond well to the previous one. For perspective, two quarter point rate hikes next year would leave the benchmark fed funds rate at 1.50% by the end 2016, still well below the 5.25% level where rates stood just ahead of the financial crisis about 10-years ago.
Inflation: Deflation is a troubling concept for markets and economists, but 2016 likely holds the exact opposite. Labor costs have historically been a significant contributor to inflation, which I expect to add an uptick to the core consumer price index (CPI) next year. Wages have picked up in recent months as the unemployment rate continues to hold at a post-crisis low. The CPI rose 2% in November, the highest reading since July 2012 and the latest piece of evidence that even when factoring in the deflationary influence of a strong US dollar and a collapse in commodity prices, inflation is perking up. I expect inflation of greater than 2% in 2016.
Global Markets: The global environment for stocks in 2016 may again be defined by opposing forces. As the Fed withdraws extraordinary economic stimulus through interest rate hikes, other major central banks,including the European Central Bank (ECB), Bank of Japan (BoJ), and Peoples Bank of China (PBoC), continue to pursue aggressive stimulus programs. Global central bank actions will likely play a significant role in driving market volatility and investor sentiment.
- Europe: With inflation near zero, the ECB has announced an extension of its current quantitative easing (QE) program past the original end date of September 2016. The ongoing program may further the decline in the euro seen in 2015, and act as a boost for European exports and earnings. Though still sluggish, Euro-zone corporate earnings have been improving and exceeding estimates by wider than average margins in recent quarters. Bucking the global trend, the region’s economic growth improved in 2015, as did job growth and business sentiment, and is expected to maintain the improved pace of growth in 2016. Even after a sharp rebound from the 2015 market correction, Euro-zone stocks are still down about 10% from 2015’s high, while valuations are close to the historical average. These factors along with ongoing asset quality improvement that supports the financial sector, the largest sector of Europe’s stock market, combine to make the region attractive in 2016.
- Japan: In Japan, exports have been impacted by slower demand from China. But this has been partially offset by the BoJ’s QE program-which has weakened the yen and improved the attractiveness of Japan’s exports-contributing to a 3.3% rise in merchandise exports to Europe over the past year, per data from Japan’s Finance Ministry. Japan’s economy posted solid growth in the third quarter; nevertheless, core inflation fell three months in a row pushing the BoJ to consider an even more aggressive pace of QE. Together with a fiscal stimulus proposal and pro-growth initiatives, including deregulation and corporate tax cuts, this should provide a positive economic and policy environment for Japanese stocks. Japanese stocks outperformed US stocks this year, and look good again for 2016.
- Emerging Markets: In 2015, emerging markets (EM) suffered a slowdown, and in some markets a meltdown. Brazil’s stock market fell over 40% and South Africa fell more than 25%. An appreciating US dollar, falling commodity prices, weak global trade and political instability hurt these markets. Trends in the dollar and commodity prices may continue to act as drags on EM stocks in 2016. EM consumers, especially in China and India, are expected to provide support to the markets. Retail sales were up 11% in China this past year driven by massive e-commerce. Though EM’s have fallen below long-term averages and are the most under-weighted by fund managers since 2006, expect further volatility as present trends continue into 2016.
Election Year: 2016’s presidential election year is sure to bring copious amounts of rhetoric leading up to the election. Once there are two candidates squaring off with actual proposals, the market’s attention will intensify. It is interesting to note that the fourth year of the presidential cycle (the election year) has historically been the second best performing year in the four-year cycle, with an average gain of 11.3% since 1928 according to Strategas Research. Take that data with a grain of salt however, especially given that the pre-election year historically has been the best by far and the market ignored that tendency in 2015 as it was the worst pre-election year since 1939.
New Year New Themes: “Big Data” Big Theme in 2016. As companies and governments are gaining access to huge amounts of data, they hope to mine through all the data to uncover insights and opportunities. They depend on innovative enterprise software, “Big Data,” companies to do that. These Big Data companies will generate billions of dollars in 2016 helping other companies and institutions organize, analyze and manage ever-rising stores of data. Mobile data traffic alone will jump 1,000% from 2013 to 2018, to the equivalent of 43,709 text messages each second, according to Cisco Systems research. Big Data and data analytics software turns those digits into actionable intelligence.
Sweet ’16: As the year draws to a close and we look confidently to the future, we remain committed to the core values associated with our mission: providing strategic investment solutions consistent with investor’s objectives and risk tolerance. We strive to make this a Sweet ’16. Happy New Year!