What to Expect in 2016: 4 Investment Outlooks for the New YearLearn more about this firm
Our investment experts provide their unique insights into economies, markets and asset classes.
What’s Inside: Topics and Authors
- Global View: Neil Dwane
- NFJ Investment Group: Ben Fischer
- Income & Growth Strategies: Doug Forsyth
- US Investment Strategies: Kristina Hooper
Politics and Policy Pushing Volatility Higher
Diverging interest rates, heightened political drama and simmering Middle East tensions add caution to Neil Dwane's 2016 outlook. As volatility rises and index returns fall, investors will increasingly look to active managers for alpha potential.
The opportunities and risks on the horizon for 2016 are similar to those that emerged in 2015. Economic growth will remain muted, monetary policy should stay extremely benign even as the US takes a divergent path, and politics and geopolitics will add volatility to the policy mix. As a result, we expect asset markets to be more volatile as well, favoring active investment styles that have the potential to deliver attractive alpha returns during a time when beta returns may be low.
Dull and fragile economic growth
Our expectations for 2016 remain cautious, given the ongoing environment of financial repression
As 2015 progressed, estimates for global gross domestic product (GDP) growth were steadily revised lower. Our expectations for 2016 remain cautious, given the ongoing environment of financial repression.
The US delivered mixed results in 2015 and we foresee a similar outcome in 2016, with the economy expanding 2%-2.5%.
China has been slowing for some time, which will have continued serious ramifications for commodity-producing countries and many economies in Asia.
Europe was a surprise in 2015, with quantitative easing (QE) and sustained euro weakness pushing growth higher. With Europe's waning appetite for austerity and the European Central Bank's commitment to QE, we are optimistic that growth rates can be sustained into 2016.
While global economic growth remains dull and fragile, there are emerging signs for optimism in the medium term. Global trade now accounts for nearly half of world GDP, demonstrating the success of globalization. New deals like the Trans-Pacific Partnership should boost trade and a similar deal between the US and Europe may be on the horizon. China's "one belt, one road" policy will also help drive investment in many developing economies.
Inflation? What inflation?
For financial repression to work, some inflation is needed to erode the real value of high debt levels. Yet inflation globally remained subdued during 2015, and there are many reasons to expect more of the same in 2016—chief among them low oil and commodity prices, lower trade prices and subdued wage increases, especially in Asia and Europe.
However, local service inflation should be resilient globally and many output gaps are beginning to close; this is traditionally a harbinger of inflation. Moreover, one "black swan" event in particular could change the game: If the serious geopolitical situation in the Middle East were to worsen and affect the supply of oil, it would be bad for economic growth—but good for inflation.
Monetary policy remains loose as divergence begins
As more central banks reduced interest rates to the bone and moved into QE mode, monetary policy around the world continued converging in 2015. Yet 2016 will see the first major divergence of monetary policy if, as expected, the US Federal Reserve raises interest rates. As a result, we expect more currency volatility, which will make it even harder to find attractive returns from international equity and bond markets.
Political uncertainty looms
Local politics are always closely aligned with monetary policy, and we expect they will shape investment returns in 2016.
- Europe had its usual rollercoaster ride in 2015, enduring another Greek crisis, and the UK's referendum on staying in the European Union will now be a focus for the region.
- Asian countries are grappling not only with China's growing assertiveness but the fallout from its economic rebalancing efforts.
- Expectations are high that Brazil's president may be impeached for corruption, thereby throwing its economy into unpredictable stasis.
- Events unfolding in the Middle East bear careful watching, with echoes of the Cold War returning as Russia and the US back different sides.
- The biggest political story in 2016 will be the US elections, with neither Democrats nor Republicans settled on a clear candidate. The electorate seems to want to try something different, although this should not produce notably different economic policies.
Investing in a world of volatility and illiquidity
Over the course of 2015, volatility returned to markets and correlations between many asset classes broke down. We expect more of this in 2016, as policy and politics highlight differences in the global economy. Within the low-interest-rate environment, many market segments have seen the growing use of extreme leverage and algorithmic trading, which is both exacerbating volatility and causing markets to become more illiquid—especially with QE causing investors to herd together in the hunt for return and income.
In this environment, we will be flexible and active to put our clients in a position to benefit from volatility at an asset-class level. We will also use in-depth research, and focus on quality and sustainability, to help them navigate markets where taking risk is a necessity. As monetary policy diverges, we expect to see our clear philosophies and long-term processes deliver the alpha that investors are searching for—particularly in a world where beta returns will be much lower and more volatile.
Fed Makes a Move, Investors Wait for More
Despite the first Fed rate hike in almost 10 years, CIO NFJ Ben Fischer says the central bank is acting too soon amid a sluggish global economy, but value stocks look set to outperform in 2016.
The new year will begin with investors facing a whole new world for US monetary policy. Having grown accustomed to a fed funds rate held near 0% since December 2008, investors must now contend with a Fed bent on tightening as 2016 gets underway. While many investors expect further hikes, I believe the Fed is jumping the gun in a US economy that doesn’t appear strong enough for a traditional tightening cycle. At its year-end meeting, the Fed cited recent employment gains and rising wages as among the biggest factors driving its decision. While the latest readings have been helpful, they hardly tell the whole story about a US economy exhibiting considerable weakness in other areas, most notably manufacturing. It appears the Fed, after signaling a tightening bias throughout much of 2015, created a situation that it just couldn’t back out of, and is attempting to save face.
Fed vs. World
While the US economy enters 2016 on a wave of steady growth, other developed economies appear to be slowing down and emerging markets are totally wiped out. Brazil, which attracted substantial capital investment in recent years, now looks like a basket case. A sharp slowdown in China and related declines in commodity prices make growth in emerging economies an even more difficult prospect in the year ahead. Substantial weakness overseas makes me doubt the Fed's ability to tighten much further as central banks in Europe, Japan and China are all moving in the opposite direction. China has been particularly aggressive with a currency devaluation intended to maintain its manufacturing sector's cut-rate competiveness. These factors will make the Fed's job all the more difficult, and investors all the more uncertain, as we move ahead in 2016.
Beware Zombie Balance Sheets
Given the relatively strong market performance and historically low interest rates in 2015, balance-sheet strength was not much of an issue, as many low-rated companies were able to borrow exceptional amounts of money at extremely cheap rates. All that appears to be changing, however, as a move to higher rates could have outsized impacts on lower-rated companies. The zombie balance sheets maintained by many of these companies in recent years will be exposed to greater investor scrutiny in the months ahead. We believe company fundamentals, particularly balance-sheet quality, will become a much more important determinant of a stock’s attractiveness in 2016. Investors will naturally seek out high-quality companies with strong balance sheets to better position themselves amid rising volatility. In this environment, we believe that active investing and astute stock selection have the potential to vastly outpace passive investment strategies.
Value Set to Outperform
Growth stocks outperformed value stocks by a wide margin in 2015, as investors bid growth-stock prices higher amid a waning era of historically low rates. Growth stocks have enjoyed great success in the years following the financial crisis, outperforming value stocks in five of the seven years since 2009. But as 2016 begins, we believe that value stocks are primed for a turnaround as investors seek more attractive price-to-earnings ratios. We're looking at the energy and materials sectors, which have tumbled in tandem with falling commodity prices and now offer good long-term value. We're also paying special attention to healthcare and consumer staples based on their better relative performance. Another source of value over the coming year is the much-maligned emerging markets, which I like from a contrarian point of view. The bottom line is that stock markets in 2016 are going to offer plenty of attractive opportunities to the value investor.
Dividends Boost Total Return
In past tightening cycles, the Fed has typically raised its benchmark fed funds rate by about 25 basis points each quarter. This time, however, I believe the Fed is going to have trouble justifying further increases until there is clear evidence of strong and consistent economic growth. And as we approach the beginning of 2016, it appears the US economy is just barely breaking even. While I don’t believe we’re heading into a bear market for 2016, I do believe that market returns won’t get much north of 5%, which is considerably less than their historical average. With a relatively flat market, I can’t overstress how important dividends are going to be for total return. In a volatile environment where market movements are anything but certain, dividends can boost your total return and take some of the sting out of capital losses.
Markets Set for Solid Gains Despite Fed Hike
CIO US Income & Growth Strategies Doug Forsyth says defaults should remain modest despite pricing pressure and rate hikes. Investors who ride out a potentially choppy market could find a solid outlook for stocks, convertibles and high-yield bonds in 2016.
Well before the Fed announced its long-awaited rate hike—its first in almost 10 years—equity and credit markets showed mixed results in the second half of 2015. Larger-cap stocks generally moved higher while high-yield bonds faced severe headwinds. Convertibles also headed lower because gains in equities were weighted in fewer companies, mostly large caps, and because of wider credit spreads.
Given the heightened volatility levels we’ve been seeing in the marketplace, the short-term forecast for risk assets is less clear and future conditions remain under scrutiny. Yet if investors are looking for signals about which way the market is headed, it is important to keep the focus on defaults and the US economy as a key indicator of market vitality. If the economy continues on a moderate growth path and avoids recession, the outlook for the performance of the stock, convertible bond and high-yield bond markets is considerably higher for 2016—we believe double-digit total returns are possible.
Among fixed-income alternatives, convertibles and high-yield bonds will be a contributor from both a diversification and a relative-performance perspective. Interest rates, earnings trends and global growth will all influence the outlook. The path for capital markets may be choppy and, at times, may require strong conviction.
Strong Support for High Yield
For the high-yield market, investors have questioned recent price action. However, spreads are wide—approximately 700 basis points above US Treasuries near the Fed hike—relative to a default rate of 2.5%. The default rate, which was low in 2015, is forecasted to rise modestly in 2016. Despite stress in select segments of the market, including the energy and materials sectors, overall credit statistics continue to support an investment in high-yield bonds and convertibles over the coming year.
For the vast majority of high-yield issuers, balance sheets, leverage ratios and interest coverage ratios remain healthy. Lower coupons contribute to a lower semi-annual interest expense burden. Another factor confirming the outlook for low defaults is the lack of near-term maturities.
Convertibles: Favorable Dynamics
Given these favorable market dynamics and investment-grade credit exposure, convertible-bond floors for the majority of the market should hold, supporting downside protection. Adding to the attractiveness of convertibles is the fact that redemptions and maturities in the convertible market should slow dramatically over the next few years. With convertible strategists predicting steady new issuance, the convertible market could grow significantly. This would further improve sector diversification as well as provide more balanced convertible opportunities.
Outlook: Moderate Growth
While market participants guess at the extent and duration of the Fed's tightening cycle, our economic outlook remains consistent with a moderate growth forecast for the US. Separately, monetary policy outside of the US continues to be overwhelmingly accommodative, with policymakers using aggressive stimulus measures in Europe and regions throughout Asia.
The Fed remains dependent on economic data, such as recent job reports, which have generally showed strength. With its new rate hike, the Fed has announced that it feels the US economy is strong enough for tightening. This should give investors conviction that the credit markets should rebound and defaults should remain low.
Notably, in the past 30 years, the US has not fallen into recession, nor have high-yield spreads moved substantially higher, without being preceded by an inverted yield curve. Yet the curve currently shows a spread of approximately 200 basis points between the 3-month Treasury bill and the 10-year Treasury note. Unless the Fed moves aggressively and is well into the tightening cycle, an extended sell-off and spread-widening in high yield would be unprecedented.
6 Investment Ideas for ‘16
Kristina Hooper translates Allianz Global Investors’ market outlook—watch for higher volatility and lower correlations as global monetary policy begins to diverge—into clear strategies for investors’ portfolios.
As investors wrap up a long year marked by short-term yet powerful swings, one big uncertainty—when rate hikes would begin—has finally been resolved. Yet even before the Federal Open Market Committee made its long-awaited decision, several key themes for 2016 had already emerged. Here's what investors should watch for globally, in the US and in their own portfolios.
4 Global Macro Themes for 2016
- Financial repression will continue in an environment of modest growth and high debt levels. Interest rates globally will remain “lower for longer.”
- While rates will stay low, monetary policy will begin to diverge globally. The US will raise interest rates gradually even as many other countries become more accommodative.
- Economic growth will be modest globally, with developed markets more resilient than emerging markets.
- Uncertainty will remain high, with a wider range of possible outcomes and potential risks—both on the upside and the downside. Expect more volatility in all asset classes.
2016 Could Be Quite Different for the US
- Divergent doesn’t mean detached. The US is part of the global economy; everything is interconnected. That’s why the Fed had so much to consider as it pondered when to begin liftoff.
- This is not your father’s rate-hike cycle. We continue to stress that the path of rate hikes is far more important than when liftoff actually begins. Our outlook calls for a slow increase in rates, with a number of plateaus, as our lower-for-longer theme stays in effect.
- As US monetary policy normalizes, US markets should also return to normal. That means higher volatility, lower correlations and reduced reliance on Treasuries as a “safe haven.” Expect fundamentals to matter more, and look for hyper-sensitivity to relatively high valuations.
- The US economic recovery is continuing, but not all sectors and regions are participating fully: Manufacturing is lagging because of the strong dollar, and energy is suffering because of low prices.
- Fiscal conditions and elections matter. Policy and politics could dominate not only the headlines, but market behavior.
6 Investment Ideas for the Year Ahead
- Maintain exposure to risky assets. Investors are facing a range of headwinds—rising rates, too-high valuations in some asset classes, low earnings growth, and mounting liquidity and political risks—yet they still need to take smart risks to meet their longer-term goals.
- Be cautious of emerging-market bonds (particularly dollar-denominated ones) and currencies. While long-term value-driven investors have a positive outlook on emerging markets, shorter-term risks—notably declining growth momentum and Fed tightening—remain.
- Seek income from alternative sources. Global financial repression makes yield hard to find, and low growth makes dividends an important driver of equity returns. Rates are rising from such a low level that investors will need to be selective, diversified and limited in exposure to vulnerable asset classes—particularly core bonds.
- Favor multi-asset strategies—particularly flexible, dynamic strategies that can adjust to changing market conditions. Different asset classes move in and out of favor, and we expect greater rotation in leadership in 2016. Investors should also look for asset classes that are reverting upward toward more normal levels.
- Maintain some exposure to inflation-sensitive investments, given that inflation, historically, tends to spike unexpectedly. Investors need to remind themselves that even in a low-inflation environment, inflation is a threat to their long-term financial goals.
- Active investing is a must, both within and across asset classes. Low returns and increased volatility may be the new normal. Investors will need to be very selective to take the right risks to grow and preserve wealth—and to protect on the downside. Correlations should decrease, making it a stock-picker's—and asset-class-picker's—market.
A Word About Risk: Investing involves risk. Equities have tended to be volatile and, unlike bonds, do not offer a fixed rate of return. Investments in smaller companies may be more volatile and less liquid than investments in larger companies. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets. Dividend-paying stocks are not guaranteed to continue to pay dividends. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Bond prices will normally decline as interest rates rise. The impact may be greater with longer duration bonds.
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation. Allianz Global Investors Distributors LLC, 1633 Broadway, New York, NY 10019-7585, us.allianzgi.com, 1-800-926-4456.