Re-visiting The Themes For 2016

We are coming to the end of January (already?), so lets take a look at our themes for 2016 and see what has happened or changed so far:

1) Volatility and Uncertainty (no change)

• I probably don't need to dwell on this, but volatility is up and will remain so until we get a better handle on the global economic picture and all the various influences on it (and there are many).

2) The US Economy (soft and getting softer)

• The domestic economy continues (for the time being) to carry the whole economy.
• Labour markets improved throughout 2015.
• Consumers (70% of the US economy) remain confident, although that does not appear to be being translated to retail spending:

• Consumers are saving, not spending.
• The strong $US and the weak global economy, especially in China and emerging economies has been negatively impacting the export economy and manufacturing data continue to be soft.
• Looking backward, Q4 2015 GDP is not expected to be anywhere close to what was expected in early 2015.
• Official data on this will be released tomorrow.

• Looking forward:

3) Commodity Prices (more uncertainty):

• There is serious concern over the massive debt that has been amassed as interest rates have remained low for such a long period of time (especially in the energy sector) and that low oil prices will make servicing that debt extremely difficult as it is expected that supply and demand factors will continue to put downward pressure on them.
• This situation not only impacts North American producers but Emerging economies who have built their economies around oil and do not have the monetary reserves to sustain their debt levels, hence a greater potential for default.

• It has been suggested that this scenario could possibly drag the US economy into recession, but one of the sharpest of economic thinkers, Mohamed El-Erian only puts this at a 30% probability.

4) Diverging Monetary Policies (even more uncertainty):

• The US Federal Reserve raised rates in December and are expected to do so again in March (tightening monetary policy), still promoting a rather optimistic view. However, yesterday's meeting and policy statement revealed concern over the global situation.
• Meanwhile in Europe, Japan and China there are expectations of further easing of monetary policy.
• Obviously, this creates uncertainty as to who has the greatest understanding of current economic conditions and that uncertainty transcends into financial markets:
• Liquidity dries up and volatility rises.

5) Geo-political concerns (rather quiet on the headlines at the moment, but lurking):

• Middle East
• Russia
• UK exit from the European Union
• Greece
• North Korea
• Global terrorism
• US political gridlock (Donald Trump ?)

6) Bond Markets:

• Yield curves are flattening: investors / traders are selling expensive risky assets and buying safe government bonds.

7) Equity Markets Remain Expensive

• Earnings growth is declining: 

• 10 year average price to earnings ratio at 14.2 times remains below the current 12 month forward expectation of 14.9 times, although well below the peak near 17 times.
• There is better value now, but economic uncertainty may continue to put earnings growth at risk.
• Investors are (finally) becoming uncomfortable with over-valued assets.

8) We Are In A Low Return Environment

• Equity markets are down by about 8% so far this year.
• Bond markets are up slightly.
• After 6 years of above average growth we must now endure below average growth that will bring us back to average growth.
• This may last well into 2016 and possibly into 2017.
• Overweight cash as a defensive asset remains prudent, but there will come a time when that cash can be put to work and we will remain vigilant for that time.

Stay tuned!

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