Did 2015 mark the peak of the cycle for risky assets?
In short: No. We are overweighting equities as we head into 2016.
As we enter 2016, global equities and high yield credit remain below their peaks reached in 2015. Are we merely part way through a correction, or did 2015 mark the year of transition from bull to bear?
No bull market can last forever, and fears mounted through 2015 that the post-crisis upswing in risk assets is finally running out of steam. The sheer duration of the rally has stimulated suspicion that we could be “overdue” for a decline: the US equity surge is now in its seventh year, making it the longest bull run since World War II uninterrupted by a more than 20% fall. Confidence was shaken in August and September by worries over China’s growth, despite the fact that, at least according to official data, growth is meeting expectations.
Where do we stand on monetary policy?
Answer: It depends. But in general, central banks are likely to err on the loose side in 2016.
Today there are simultaneous calls for the US Fed to tighten and to ease.
Similarly, the ECB is due to end quantitative easing by September, but there are also calls to expand the program. Where do we stand in the monetary policy cycle? Will the world finally transition away from central bank life support?
Can China control its slowdown?
Answer: Yes and no. It cannot stop a slowdown, but should avoid major disruption.
A disorderly crisis in the China remains outside of our base case, but ranks as one of the most serious potential tail risks to financial markets in 2016. In the first year of its 13th Five Year Plan, can China shift its growth model and control its slowdown?
Are we close to the bottom in the EM/commodity downturn?
Answer: Yes. But the emerging market hype is unlikely to return.
After underperforming developed markets for three years, and with Brazil and Russia in deep recessions, the gloom on emerging markets seemed all-consuming at times in 2015. Commodities have plumbed multi-year lows. Is this this dark before the dawn? 2016 could provide us the answer.
Emerging markets have lost much of their shine since 2013. Their equities have lagged developed markets by almost 50% over that period, and GDP growth has more than halved since a 2010 peak. A combination of waning investor enthusiasm and cash outflows by residents means that EM are set for their first net capital outflow in 27 years in 2015, according to the Institute for International Finance.
Is 2016 the year inflation returns?
Answer: Probably. But it also probably doesn't matter.
Bank deleveraging, commodity crashes, technological change, oversupply, secular stagnation... Pick your reason, but inflation has been absent since the financial crisis, despite central banks' efforts. Will inflation move higher in 2016?
The hyper-inflation that some economists feared from central banks’ money printing after the 2008 financial crisis did not materialize. Instead, price rises have fallen persistently below official targets in recent years. Three-quarters of the 34 OECD nations had inflation of 1% or below in late 2015. Ten OECD nations were even experiencing falling prices as of August. That compares to a 2% target set by most developed nations.
Will politics affect markets in 2016?
Answer: Yes. But we expect drama without tragedy.
The US presidential election, Brexit, a migrant crisis in the EU, and an economic crisis in EM. Politicians and electorates will play a crucial role in 2016. Will unpleasant political surprises in 2016 put economic growth at risk?