Investment Outlook Update: Market Volatility is Here to Stay

As investors know, global markets got off to a rough start in 2016. By mid-February global developed equities had lost nearly 20% from their 2015 peak1. They rebounded by around 10% mid-March, but we expect volatility to be a headline throughout 2016.

This volatility will continue to be driven by China fears, U.S. Federal Reserve monetary tightening, U.S. recession concerns, bank balance sheet worries, and soft corporate profits. Moreover, the move to negative interest rates in Europe and Japan has triggered fears that central banks have run out of easing options. Negative rates also tend to squeeze the margin between banks’ borrowing and lending rates. This squeeze could, in turn, hurt bank profitability, and end up making things worse for the markets.

In our 2016 Global Market Outlook Annual report, we favored mid-to-low single digit returns for global equities, along with a gradual rise in long-term interest rates. We’re holding to that view, with the exception we think equity growth is more likely to be in the low single digits. Moreover, we’re now seeing corporate profits weakening, softness in global trade and manufacturing, and slightly higher risks for emerging markets. These elements all contribute to a less supportive environment for equities.

That said, we’re not forecasting a sustained bear market – provided the U.S. does not fall into recession. Right now we see recession as a low probability over the next several years. It’s true we’re deep into the current business cycle, but we’re not seeing excesses in the U.S. economy that could trigger recession.

In late December, we discussed three key indicators in our 2016 Global Market Outlook and continue to keep an eye on them in our upcoming Global Market Outlook Update. These are:

  • U.S. non-farm payrolls. We’re seeing strong jobs growth without much wage pressure. So long as that holds, it reduces pressure on the U.S. Federal Reserve (the Fed) to tighten its monetary policy aggressively.
  • S&P 500® Earnings per Share growth. We previously had forecasted 3-5% growth for 2016, down from 7% in December 2015. Now, we’re a little more pessimistic, forecasting 2.7 % growth.
  • Emerging markets exports. We’re seeing a deepening slump here, with both South Korea and China experience double-digit declines.

Given the current state of these indicators, Europe and Japan continue to be our preferred exposures, where monetary policies are providing tailwinds. Meanwhile, we’ve become more cautious on emerging markets.

The valuation of U.S. equities is expensive, and its business cycle score struggles under downward pressure. A strong upward trend in the S&P 500 from 2012-2015 had made it easy to “buy the dips.” Now, however, negative price momentum and a U.S. business cycle that is, at best, neutral makes us think it’s better to “sell the rallies” rather than try chasing the market higher.

Other key trends we’re watching:

  • Government bonds. We don’t see much value here. But, as the cycle is becoming less favorable for equities, it is becoming a bit less unfavorable for government bonds.
  • End of the bull dollar. It’s been a great three years for greenbacks, but we think they’re running out of steam. Yet the U.S. dollar might have one more move left against emerging currencies such as the yuan and commodity currencies.
  • Oversold equity markets. We think most equity markets have over-sold. Moreover, we now also see downside risk from a waning business cycle and negative price momentum.

To see more detail, take a look at our 2016 Global Market Outlook – Q2 Update, which will be available by month’s end. It lays out key investment themes that we’re watching globally for the balance of 2016 in greater detail.

1 FTSE Developed Index is a market-capitalization weighted index representing the performance of large and mid-cap companies in Developed markets. The index is derived from the FTSE Global Equity Index Series (GEIS), which covers 98% of the world’s investable market capitalization.

Disclosures:

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.

Investing involves risk and principal loss is possible.

Forecasting is inherently uncertain and may be incorrect. It is not representative of a projection of the stock market, or of any specific investment.

Investments in non-U.S. markets can involve risks of currency fluctuation, political and economic instability, different accounting standards and foreign taxation.

The S&P 500®, or the Standard & Poor’s 500, is a stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ.

FTSE Developed Index is a market-capitalization weighted index representing the performance of large and mid-cap companies in Developed markets. The index is derived from the FTSE Global Equity Index Series (GEIS), which covers 98% of the world’s investable market capitalization.

Russell Investments is a trade name and registered trademark of Frank Russell Company, a Washington USA corporation, which operates through subsidiaries worldwide and is part of London Stock Exchange Group.

Copyright © Russell Investments 2016. All rights reserved.

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