At the end of 2015, we published our thoughts for the coming year in a piece entitled ‘The Year Ahead 2016’. A year on, we review how those forecasts turned out...
Key: Correct / Partially Correct / Incorrect
At the beginning of each year we publish our thoughts on the coming year – as do many in the finance world. However, in the spirit of 7IM, we try to be clear and transparent – which means having a look at how things actually turned out compared to our predictions! Therefore we also publish an analysis of those forecasts at the end of the year – which you can read below.
At this time last year, we wrote that 2014 "managed to confound expectations" as events made a mockery of broad market predictions. This year, the opposite case could be argued - that the major developed asset classes performed as they were supposed to in 2015… it just didn’t feel like it!
In Europe and Japan, the effect of large scale Quantitative Easing (QE) programs was to drive equity markets higher, and keep bond yields suppressed, as forecast. In the US and UK, with monetary policy tending towards tighter rather than looser, government bond yields rose and stock markets ended the year almost flat, again as forecast. Our ‘What we got right and wrong in 2015’ piece certainly looks more correct than incorrect.
However, 2015 has been a year to test investors’ commitment to the destination, with the journey far from smooth. Timing the market has been almost impossible to do consistently, but at the same time maintaining conviction in positions has been just as challenging.
For example, although the German 10 year bond yield is the same now as it was at the start of 2015, 0.5%, the path has been bumpy to say the least. During the course of the year the yield has been as high as 1% and as low as 0.07% (that’s not a typo – for every £100 you lent the German government, you would have been paid 7p a year for ten years!).
Similarly, the European equity market swung between 3,800 and 3,000 as headlines cycled through Greek crises, Mario Draghi, border closures and ISIS attacks. Yet the market looks set to finish the year around 10% above where it started.
So what does 2016 have in store? Is the slow and steady growth train gathering momentum? Will central bank policy divergence cause chaos or calm? Are surprise events going to help, hinder or just be ignored? Below, we try to sketch out how we see the next twelve months unfolding.
2016 – When good news becomes good news.
We hope to have a year where stronger economic data is rewarded with a positive market reaction. Now that the Federal Reserve has increased interest rates, investors will seek positive confirmation of the strength of the US economy, rather than looking for reasons to stay in emergency monetary policy mode.
Review: Correct. Despite the shocks in the political sphere in 2016, pretty much every global economy did as well, or better than forecast at the start of the year. Nowhere was that more clearly demonstrated than in the expectation of the Federal Reserve raising rates coming into December – with the markets giving it a 50% probability from the end of August, and moving steadily towards 100% throughout the autumn. Positive confirmation indeed – time for the Fed to get ahead of the curve!
Having said that, most of the rest of the developed world remains in emergency mode – something we expect to see fade throughout 2016. We may not see the central banks of the UK, Japan and Europe tighten policy in the next twelve months, but they will most likely start talking about it.
Review: Incorrect. Aside from the UK, where the referendum result meant underlying economic forecasts went out of the window, the Bank of Japan and the European Central Bank (ECB) have moved further into ‘emergency’ territory. It does seem as if the economies are benefitting, but for now there seems to be very little sign of a tighter stance in policy.
Markets are going to continue to experience shocks (true in any year), and the violence and speed of these is unlikely to diminish. The current environment is likely to persist – with long periods of tranquility punctuated by short episodes of extreme volatility.
Review: Correct. (if a bit of a cop-out prediction!). Different asset classes experienced their shocks at different times. We began 2016 in terrible fashion, with a cascade of worries hitting the equity markets (China, Deutsche Bank, oil were just some). Then though we saw nearly six months of steady growth, Brexit caused further equity turmoil in June, before rallying once more. Finally, following the US election, bond market volatility rocketed up – we are still dealing with the fallout from this.
Managing money will be as difficult as ever, and it is going to be more crucial than ever to focus on the long term outcomes. We will keep trying to ignore the surface ripples and instead look for the deeper currents that affect the financial world over years, rather than weeks or days.
Review: Correct. In the sharp correction in February, we saw a number of research reports published telling investors to "SELL EVERYTHING". That kind of headline does indeed make managing money difficult! However, we maintained our view that the global economy was not broken, and that another financial crisis was not heading our way – and now, at the end of the year, have been rewarded for that conviction.
Looking in more detail at the various regions:
US Dollar strength wanes. A non-consensus view– we don’t believe that US rate hikes will lead to a sustained rally in the US Dollar throughout 2016. Since mid-2014, the US Dollar Index, which compares US Dollar to a broad basket of global currencies, has rallied 20% - we believe this has been in anticipation of the Fed finally beginning to increase rates. With that occasion behind us (finally), the catalysts for a further rise in value are limited. The US Dollar is likely to move sideways to down against the Euro throughout the next twelve months – reversing the trend of the past year or so.
Review: Incorrect. For the first part of the year, the Dollar traded broadly sideways vs. both Sterling and a basket of its trading peers. Firstly Brexit caused a sharp fall in the value of Sterling, and then the increasing likelihood of a rate rise in the US saw US Dollar strength vs. almost every other currency. We end the year with the US Dollar stronger by 3% against a global basket, and up by over 15% compared to the Pound.
Markets keep faith with Janet Yellen. The 0.25% December rate rise was incredibly well managed – with no savage market reaction in either direction. We expect that Ms Yellen will take heart from this successful guidance approach, and keep the information flow coming throughout the year.
Review: Correct. The interest rate rise in December was greeted by barely a flicker in the markets. The fact that headlines were more concerned with the future of the US under President Trump meant that for the first time since the global financial crisis, Federal Reserve meetings were not ‘must-watch’ events.
Inflation returns. Or, perhaps more accurately the threat of deflation vanishes. Each monthly CPI calculation factors in the year-on-year decline in the price of oil, which throughout 2015 averaged 43%. If the oil price stages a rally from its current level ($37) back to around $40, this drag on inflation will start to diminish – the price per barrel in January 2015 was $48. The mathematical base effect kicker should come through in Q1, but it may surprise those who haven’t been paying attention.
Review: Correct. The base effect has indeed come through, but the bigger factor is probably expectations for growth increasing. Whether due to the Trump effect or just the public acceptance of economic resilience, inflation is back on the horizon.
Elections grab the headlines. Particularly given the potential for a hot-headed Republican candidate – Donald Trump is certainly fulfilling the hot-head side, although it remains to be seen how serious a candidate he really is. The truth is that without knowing the candidates, it is difficult to forecast the outcome.
Review: Correct. Oh wow, correct! You would have thought that an investment that directly correlated from election related news would have been the trade of the year. Unfortunately the closest proxy, Twitter, lost 20%!
US companies keep making money. The strength of the US Dollar made 2015 a struggle for US companies – yet earnings (outside the oil sector) still increased by around 5%. The US consumer has been ‘about to spend’ for a few years now – and at the risk of further jinxing it, we believe that the combination of rising earnings and increased optimism in the lower income segment of the US economy is now at the right level to generate spending. The growth may come through increased volume of sales increasing rather than margin expansion through cost-cutting.
Review: Correct. Even with the drag from the Energy sector, US companies in aggregate managed to increase earnings by around 2% - suggesting that underlying consumer demand is very robust.
Some energy companies default in the coming year. The principles of capitalism dictate that companies who no longer have a business model do not last. The current environment of low commodity prices will be exacerbated by the coming rise in funding rates – and those who have been ‘bailed out’ by the Fed will now have to face the consequences. Investors should remain calm and look at the underlying businesses, leading to casualties, but no widespread carnage.
Review: Correct. Defaults from over a dozen small energy companies came through as expected – but the rapid rally in oil prices through the first quarter probably alleviated the pain somewhat. Carnage was avoided.
Greece isn’t the word… 2016 could be the year in which Greece is not the focal point for a Eurozone membership crisis. Of course that’s not to say we won’t have a couple of moments of existential doubt. Towards the end of 2016, France will be preparing for its General Election the following April, and there could well be a resurgence of Marine Le Pen’s National Front movement. We will also have the negotiations in the lead up to the British Referendum – and discussion of EU membership has, to date, never been a smooth process for anyone involved. Add into this the ongoing migration from the Middle East, and it seems like there is no shortage of bumps in the European road.
Review: Correct. Greece seems a distant memory – but that’s mainly because there are indeed other ‘bumps’ in the road – Le Pen and Brexit being two of the more obvious.
Economic expansion continues, as austerity measures ease and lending increases. As consumers begin to loosen their purse strings, European retail sales could follow the trend set by car registrations (above 9% growth through most of 2015). At the same time, European exporters should be well placed in the coming year, with input costs down and global demand rising.
Review: Correct. European GDP growth remained resilient, coming from a variety of sources, including the German consumer.
Unemployment continues to decline. If job creation continues at a similar rate, 2016 could be the year when unemployment falls below double digits for the first time since 2009. That sort of move would act as a key driver of the growth we are looking for above, as domestic demand has been a lacking factor thus far in the recovery.
Review: Correct. Eurozone unemployment is now below 10%, and has continued to decline throughout the year.
Mario Draghi loses his mojo… This time last year we were looking for ‘Super Mario’, yet just twelve months and €720bn later, ‘Draghi Doubts’ are more appropriate. Mr Draghi under-delivered in the December 2015 ECB meeting, from the market’s point of view. In the world we describe above though, it may not matter. As long as European growth returns in the first half of 2016, he (and his bazooka) may not be called upon again. If the occasion arises though, there will be scepticism around the possible extent of any action.
Review: Incorrect. Mario Draghi increased the scale of QE in March 2016, as well as expanding the range of eligible assets to purchase. By the end of 2016, he had extended the duration of the program too. No loss of mojo here.
Markets start demanding results… For three years Japan has been given the benefit of the doubt on its economic recovery. In many ways, that is surprising in a world where short-termism has dominated investors’ minds – although the trillions of Yen of QE probably helped. With the Topix index up an average 29% a year for the past three years, 2016 could see increased scrutiny of how well the underlying economy is actually doing.
Review: Correct… and then Incorrect. For the first six months of the year, Japanese equity markets were on a downwards trend – falling over 20% from the beginning of 2016. During the second half of the year though, the Topix began to rally, and is set to finish the year flat.
...and the economy doesn’t quite deliver. Since Prime Minister Abe’s arrival, Japanese GDP growth has averaged around 1% a year; approximately the same as the 10 year average. Structural reforms take a long time to feed through, and it is quite possible that this lack of expansion becomes more noticeable in a year when the media will be highlighting the strength of the US economy.
Review: Correct. However, expectations were so beaten down through the middle of the year, that even lackluster growth has been welcomed by the market – and indeed by the Bank of Japan (BoJ).
No monetary policy actions taken. Sluggish growth in the economy will not be enough to prompt the Bank of Japan to take further easing action – they already own around 1/3 of the Japanese Government bond market. Short of a severe global slowdown (which we do not expect), Governor Kuroda will keep what remains of his powder dry.
Review: Incorrect. The BoJ made a technical adjustment to the composition of their purchases, which has been viewed as easing by much of the market.
The business of automating other business. As we mentioned last year, Japanese robotics development is world-leading. As various industries seek to automate their manufacturing processes, there will be large profits to be made in helping them do so. Expect to see Japanese companies start offering a kind of ‘automation consultancy’, perhaps creating a new business model as they do so.
Review: Incorrect. Automation has made the headlines, but in a negative way – being essentially the younger, tech-savvy brother of outsourcing. A surefire way to earn Donald Trump’s scorn is to offer a service that seeks to reduce the amount of human labour needed by companies.
Steady state economy. Despite accusations every year of the death of industry in the UK, we manage to churn out GDP growth of around 2-2.5% a year. Expect a similar number in 2016.
Review: Correct. Brexit has had a far bigger impact on the headlines than it did on growth. A final figure of 2.5% for UK GDP in 2016 would not be a surprise.
‘Brexit’ becomes a word we’re sick of hearing. This is not a difficult prediction to make. 2016 is going to see a constant stream of screaming headlines and shock polls, and there will be celebrity spokespeople gearing up even now to campaign one way or the other. With no firm date for the referendum agreed, and negotiations with the EU in their infancy, this media deluge is going to be even lighter on facts than usual. We’re looking forward to it.
Review: Correct. Will probably roll this one into 2017. It’s worth noting that we did not forecast Brexit one way or the other at the start of the year. Due to the uncertainty surrounding the vote, we decided not to assume anything.
Bank of England doesn’t raise interest rates. Mark Carney has said he intends to stand down as Governor of the Bank of England after five years – which takes him to November 2017. Could we see him leave office having taken absolutely no action in his time there? It seems a long way off, but markets currently forecast the first UK rate rise coming in February 2017. If inflation remains low over 2016, that could well be pushed out further.
Review: Partially Correct. Half points here – no rate rise, but a failure to predict a cut.
House prices to go sideways. Recently announced government initiatives have very different timescales – which could see demand dropping off slightly in the property markets. Buy-to-let investors will see stamp duty increase by 3% from April next year, an immediate cash hurdle to buying a property. Potential first-time buyers now have the Help-to-Buy ISA that adds an extra £3,000 to their deposit, but it will take savers five years to get the full benefit. This mismatch may see a fall-off in demand in the middle of next year.
Review: Incorrect. We saw a fall-off in demand, but outside of high-end London properties, prices continued to rise. Brexit has knocked confidence, but the underlying demand swell still far outstrips supply of new homes.
Global investors will embrace China in 2016. Following the turmoil in the summer of 2015 surrounding the Renminbi devaluation, Chinese authorities have been recovering their poise and regaining investors’ trust. As the gradual decline of China’s manufacturing sector becomes the central case, other areas of China’s economy will come into focus – internet and e-commerce stocks such as Alibaba and Tencent are already making headlines in the Western world. In June, there is the MSCI’s potential addition of mainland listed shares to the broad Emerging Market indices.
Review: Incorrect. The start of 2016 saw more Chinese turmoil as the stock market crashed through automatic trading stops. Following that, the wider world decided that China was too much of a basket case to be investable, and largely kept away. Since the lows of the first quarter though, the Shanghai index is up nearly 20%, and policymakers have been putting on a masterclass in communication. Too little too late for 2016 though.
Economic humiliation of commodity producers fades… Russia, Brazil and South Africa, along with their smaller counterparts, have all borne the brunt of price declines across the commodity spectrum. Monetary policy has been adjusted up or down as necessary, with governments and businesses beginning to adapt to a world of lower raw materials prices. That’s not to say these economies will start booming though.
Review: Correct. Russia and Brazil have been among the best performing markets this year. Currencies have also strengthened, but really it has been the commodity rally, rather than any structural change in these economies.
…but popular opinion may cause political upsets. When an economy suffers, its people suffer, and they, understandably, place the blame on their leaders rather than on external conditions. The political situations in Brazil and South Africa change so quickly that they render predictions useless. Perhaps the best that can be said is that this time next year, there could be a whole swathe of one-time politicians looking for a new job. The outlier is Russia, where the regime is stable and Mr Putin is growing sensitive to war-weariness in the population. In addition, EU sanctions may be lifted next year from the EU, further decreasing tensions in Eastern Europe.
Review: Incorrect. Predicting political upsets in Emerging Markets is not a heroic call. A failed military coup in Turkey, the impeachment of the Brazilian President are all par for the course…
The myth of de-globalisation vanishes, as the realisation sinks in that trade links have increased in scale over the past few years. This should help to dispel the negative sentiment in Asian exporters, who should also see an additional boost from their weaker currencies.
Review: Incorrect. De-globalization now seems to be the order of the day – not just in the emerging markets, but all through the developed markets too. Negative sentiment about exporters has picked up, rather than vanished.
This commentary has been produced by Seven Investment Management from internal and external data. You should not rely on it as investment advice or act upon it and should address any questions to your investment adviser. The value of investments can vary and you may get back less than you invested.
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