Outlook 2016: Not a barnburner

However, that’s not to say that global economic growth will be strong this year. For example, the vast majority of the 17 portfolio strategists and economists consulted for Investment Executive‘s (IE) 2016 Global Outlook and Asset-Allocation Report (pages 15-34) are not expecting growth of more than 2.5% in the U.S., the world’s biggest economy.

In addition, the slowdown in China’s economy, which initiated the recent global sell-off, will affect the economies of countries around the world negatively.

“It’s looking like another year of below-trend economic growth, with almost no countries growing above potential,” says Peter O’Reilly, head of the global equities team with I.G. Investment Management Ltd. in Dublin.

The lackluster economic outlook is not surprising. Economic growth has declined as the populations of countries age, which reduces the proportion of the people working. The maturing of China’s economy has ended the base metals super-cycle. And there is little room for more fiscal stimulus, given government debt levels in the U.S., Europe and Japan. These debt levels will continue to climb in the absence of major reforms of social assistance programs.

Those factors do not represent a recipe for strong earnings growth. And there are many risks – including a hard landing for China’s economy, faltering growth in Europe and Japan or even the U.S., and a strong U.S. dollar (US$) compounding problems in many emerging markets.

Market volatility is expected to be prevalent this year. But volatility isn’t all bad; it provides opportunities to pick up quality stocks when their share prices are weak temporarily.

There now is little inflationary pressure. Indeed, the concern among the central banks and the strategists consulted by IE is about deflation developing if economic growth weakens in Europe and Japan. For now, that risk is being held at bay by the large quantitative easing programs in both regions – but it isn’t dead. There also is deflation risk in emerging markets, in which growth is slowing or negative in general.

Nevertheless, the U.S. Federal Reserve Board raised its overnight rate in December to 0.5% from 0.25%, and the Fed has indicated that there could be another four 25-basis-point increases this year. However, financial markets are pricing in only two hikes – and that’s all that many of IE’s strategists are expecting.

“I think the markets have it right,” says Todd Mattina, chief economist and strategist, asset-allocation team, with Mackenzie Financial Corp. in Toronto. He says there are internal tensions in the U.S. economy: on the one hand, jobs, wages and housing are fairly robust; on the other, the high US$ is dampening exports and low oil prices are devastating the energy sector.

The Bank of Canada (BoC) won’t raise its overnight rate in tandem with the Fed, given the negative impact of low oil prices on Canada’s economy – but here is a possibility that the BoC could lower that rate.

That action could push short rates into negative territory, something that’s already happened in Europe without negative consequences. (See story on page 26.)

Stock-picking will be of paramount importance this year. And although many stocks are fully valued, O’Reilly says, “There are still some good companies.” He suggests looking for companies that generate free cash flow and have an independent growth strategy that is not dependent upon global growth.

Global strategists consulted for this report favour European and Japanese equities over U.S. stocks in general, saying the latter are fully valued to overvalued.

There also are some opportunities in Canadian financials and other non-resources equities, and even some possibilities in energy. (See stories on pages 20, 22 and 23.) Some of IE’s strategists are overweighting energy on the theory is that if oil prices creep up to the mid-US$40-a-barrel range from US$37 (at which they ended 2015), quality energy stocks are likely to rise even more from the unreasonably low levels at which they sit.

In line with this, Clément Gignac, senior vice president and chief economist at Industrial Alliance Insurance & Financial Services Inc. in Quebec City, who foresees oil prices reaching US$45 a barrel by the end of this year, suggests overweighting Canada for the first time in three years.

Emerging markets are sleepers. They were hammered last year, and even relatively small improvements in their economic prospects could move stock valuations up from the current very low levels. (See story on page 32.)

Another sleeper is gold. Few portfolios strategists consulted by IE are interested in investing in gold bullion, except as an insurance policy should economic prospects deteriorate badly or geopolitical tensions rise sharply. But gold prices could move up in reaction to the turmoil surrounding China’s need to devalue its currency.

In Timmer’s view, the turmoil in China “is all about liquidity – and no one knows how long [the unrest] will go on.” China’s government has been buying the renminbi and selling the US$ to stem the downward pressure on China’s overvalued currency so that it doesn’t decline too quickly.

However, because this strategy is unfolding as the Fed is increasing interest rates, China’s markets are worried about whether there’s enough liquidity to support further increases in stock prices.

Most of the downward pressure is on oil and other resources prices, emerging-markets equities and commodity-tied currencies, such as the Canadian dollar, Timmer says. Thus, he expects the pressure to continue until the renminbi reaches equilibrium and the Fed stops raising interest rates.

Charles Burbeck, co-head of global equity portfolios with UBS Global Asset Management (U.K.) Ltd. in London, doesn’t believe there’s a fundamental problem with China’s economy: “This is part of the bumpy ride as the Chinese authorities try to move from heavy control on markets, interest rates and bank loans to a more liberal, market-friendly structure.”

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