At the beginning of every year, many of our clients think about market-moving events that could materialize over the next 12 months—all of which are possible and none of which are certain. With the perspective of a full year in front of us, we will assess how ten scenarios—five good and five bad—could play out for investors in 2016.
The good
- Russia rehabs relationship with EU. Russia could be coaxed back into a stronger relationship with the European Union, reducing trade tensions and sanctions. Economic activity and investment would then return to Eastern Europe and to key industrial segments such as energy and consumption. Tensions surrounding Ukraine would subside, allowing the economy to stabilize, supported by a strong 2016 harvest. Further out, geopolitical tensions could fall in “Syraq” as the United Nations becomes more focused and effective in fighting the Islamic State, permitting supply pressures on oil to fall further—perhaps below $20 per barrel—thereby boosting economic activity globally.
- Rising local wages. Inflation in urban areas could remain robust in 2016, leading to growing evidence of sustainable domestic inflation globally, which would then begin to support rising local wages. Growing political backing for an increase in minimum wages would add further support. While global goods prices may fall because of overproduction and high inventories, domestic cost-push inflation could help drive wage increases and momentum in consumer spending. If the depletion gap in oil production tightens supply in 2016, inflation might settle within the desired range of the world’s central banks. This would provide an optimum environment for financial repression to work, favoring equities over bonds in 2016.
- Further European integration. The journey to the “United States of Europe” may well make further progress in 2016 as EU policy promotes further industry and market consolidation, spreading out from telecommunications and media to the retail, service and insurance sectors. Preparations for MiFID 2 (Markets in Financial Instruments Directive 2) could lead to changes in the advisory, savings and pensions landscapes across Europe, as banks and asset managers try to anticipate changes in client behaviors. Regional and international companies might become increasingly attracted to the consolidation opportunities in Europe, leading to further outperformance for the region’s equities.
- China begins to rebalance economy. China’s economic growth might start rebalancing as the next five-year plan is implemented and the banking industry modernizes. The big Chinese banks will continue to protect the ageing state-owned enterprises while new banking entrants, like Alibaba, deploy savings and capital to the new consumer and service markets. The “one belt, one road” policy is increasingly allowing China’s excess productive capacity to be used more efficiently. And with the International Monetary Fund’s SDR (supplemental drawing right) inclusion, China will be able to rebalance its own national savings surpluses and flows more constructively. This rebalancing would allow Asian economies to respond with domestic initiatives to restore growth throughout the region during 2016, further buttressed by economic rejuvenation in India and Indonesia.
- Short tightening cycle by the Fed. After a brief period of interest-rate hikes, the US Federal Reserve may stand pat ahead of the US presidential election. Holders of long positions on the US dollar might begin to capitulate, causing the currency to weaken during 2016. This would curtail the headwinds facing most emerging markets and allow commodity prices to rise, further releasing the fiscal pressures on commodity-exposed economies. With the European Central Bank and Bank of Japan still active in markets, the global economy could receive a liquidity burst that causes global equities to generate double-digit returns!
The bad
- Rise in Europe’s real interest rates. Despite the ECB’s monetary policy and negative interest rates in the euro zone, we could actually see an increase in the real interest rates charged to European consumers, as happened in Switzerland in 2015. This would depress access to credit and hurt the economy. The latest ECB transparency report reveals that euro-zone banks are earning 10 to 20 per cent of their profits from the long-term refinancing operation carry trade, which will fall in coming quarters as ECB quantitative easing drives out returns. Falling earnings and increased regulatory capital requirements look to further dampen performance for bank shareholders in 2016.
- Capital investment falls. Capital expenditure and investment plans may drop across the world in 2016 as China rebalances, while excess manufacturing production and exports could exacerbate global pricing difficulties. This would cause more capacity closures and diminish maintenance operational expenditures, all within a global economy with high inventory-to-sales ratios, leading to decreasing industrial production throughout the year. Many emerging-market countries, including Brazil and South Africa, could slip into a vicious vortex of declining fiscal revenues and increasing political crises, adding to growing headline volatility from politics and geopolitics.
- Middle East becomes messier. Turkey could become even more embroiled in the “Syraq” disaster, resulting in local nationalism from the Kurds and other local groups exacerbating the “wars on the ground”. Egypt, too, may experience more political and social stress from both African migration and Islamic militancy, bringing the hawks in Israel to the fore and raising geopolitical tensions near the breaking point. Oil supply shocks would then occur, with prices spiking above $100 per barrel, causing the global economy to fall into a recession.
- Two-tier credit market. Corporate credit markets might start to tighten further as central-bank policy divergence continues during the first half of 2016. This would create a two-tier market for credit as strong mega caps access markets easily while weaker emerging-market countries and troubled sectors like mining, retail and oil are pushed out, further depressing investment and growth opportunities for the global economy. With governments squeezing out the private sector from investment, investors might seek to leave the credit markets but find themselves caught with low levels of liquidity, which would generate poor pricing and volatility.
- Global pandemic appears. Super strains of antibiotic-resistant bugs could appear throughout the world’s health care systems, leading to plague-like illnesses akin to those of the Middle Ages. With the global population mostly over-exposed to antibiotics, there would be no natural defense to these bugs, especially since the pharmaceutical industry has allocated few new resources to finding new antibiotics. Travel and leisure could then be affected by rolling outbreaks of older traditional illnesses like tuberculosis and diphtheria, as well as new Ebola-type infections.
Mr. Dwane is a portfolio manager, a managing director and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook. Mr. Dwane is a member of AllianzGI’s Equity Investment Management Group and a portfolio manager for AllianzGI European Equity Fund. He has a B.A. from Durham University and is a member of the Institute of Chartered Accountants.
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
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.
AGI-2016-01-14-14269
