2016 promises to be a better year for equities than 2015, a year where markets were shaken by weaker growth in emerging markets.
The outlook for economic growth in 2016, particularly in the developed world, is much healthier than at the start of 2015, which should be positive for equity markets, including the US. Global growth still remains somewhat fragile with trade and manufacturing activity sluggish.
During 2015 there was the potential deflation issue that originated in the emerging markets and was reflected in falling commodity prices. Deflation can have a detrimental economic impact, initially it leads to a decline in trade and this may remain for the foreseeable future as China and the rest of the emerging world are unlikely to stage a recovery any time soon. But deflation also has positive effects, resulting lower commodity and oil prices and in many other goods which provides a boost to real incomes.
In 2015, consumers increased savings on the back of lower energy, commodity and other goods prices. This effect is likely to be short term as consumers return to spending and this is happening in the motor and housing sector. US consumption will continue regardless of an interest rate increase and the economy may still post a strong performance. The US economy may well continue to support the global economy, when many developed and emerging economies are still struggling. In US-dollar terms, the US market is expected to outperform.
In Australia there are some risks as the economy navigates a transition from mining-led to broad-based growth. A cyclical economic recovery is likely to emerge over coming years as the drag from mining investment fades. The growth rate of the economy has gradually slowed from around 3.75% in 2000, to 2.75% today. This has been driven by a combination of slower credit growth and slower productivity growth. Potential growth is likely to remain below 3% over the medium term.
One of the key themes for investors in 2016 will be innovation and this is set to change the shape of markets in a number of industries such as in technology through social media and the internet, gaming online and in pharmaceuticals. Innovation will transform global equity markets, creating a new environment in which US leadership will continue to thrive. The Nasdaq Composite Index will benefit from the disruptive forces emanating from within information technology and biotechnology, sectors where earnings momentum is strong. Active fund managers may be able to take advantage. Overall, the stock market will divide between the sources of innovation and the remainder of the economy. We can expect that investors will once again speak of ‘old’ and ‘new’ economy stocks, much as they did in the late 1990s. Innovation stocks and sectors will be a key source of returns for selective longer-term investors.
The prospects for Europe are gradually improving with the recovery in domestic demand. The European Central Bank continues in easing monetary policy although currency weakness will remain a focus in that the euro is unlikely to strengthen in the short term for economic recovery.
The outlook for global emerging markets looks uncertain. Growth is slowing and investors can expect further weakening of currencies across emerging markets especially if the US dollar strengthens. But in emerging markets, it is important to distinguish between stock market performance and the economy, as their paths may be diverging. In anticipation of economic weakness in China and emerging markets overall, emerging and Asian stock markets had a negative year in 2015. The adjustment in emerging-markets stock prices, and the three-year underperformance, may now be coming to an end which is the point at which careful investors might start looking for opportunities. 2016 will be another challenging year but stock prices have largely been discounted.
The outlook for global stocks is broadly unchanged since 12 months ago, with target returns of 7% +.
Australian and global ex Australia stocks do not appear to be overvalued.
Going forward, the investment environment is likely to be more challenging and volatile.
Investors with an appropriate level of discipline, diversification, and patience are likely to be rewarded over the next decade with fair inflation-adjusted returns.