Russell Investments' 2016 Annual Global Market Outlook: The Fed awakens as business cycles mature, valuations stretch
- Strategists expect robust economic growth in developed economies
- The pace of Fed hikes seen as key global market driver in 2016
SYDNEY, 12 January – Russell Investments has released its 2016 Annual Global Market Outlook report, detailing key investment insights, economic forecasts and market expectations from the firm’s global team of investment strategists.
Russell Investments' strategists describe a reasonably robust outlook for major developed economies, which have few imbalances and possess spare capacity. They expect gross domestic product (GDP) increases of 1.5% to 2.0% in the Eurozone and 2.0% to 2.5% in the U.S. In contrast, they believe emerging markets are not yet at the bottom of their cycle and could remain under pressure from continued low commodity prices, a strong U.S. dollar and weak exports.
"The economic and market cycles are ageing, but the good news is that we don't see a recession on the horizon," said Andrew Pease, Russell Investments' global head of investment strategy. "The less positive news is that the upside for investment returns looks fairly limited in 2016. We believe the winners in 2016 will be those investors that 'hope for the best, but prepare for the worst' and have the governance structure to be tactically astute."
The strategists' favoured scenario for investors in 2016 is mid-to-low single-digit returns for global equities, led by Europe and Japan, which they expect will modestly outperform cash and fixed income. This scenario includes a gradual rise in long-term interest rates as the U.S. federal funds rate increases to 1.25% or 1.5% by the end of 2016. Further equity upside in the U.S. will be determined by corporate earnings power, according to the strategists, and a belief that the U.S. unemployment rate should fall to 4.5% (or lower) by the end of 2016. This scenario could trigger upward pressure on wages, which would eat into profit margins.
Strategists don't expect a recession in Australia
Russell Investments' strategists expect Asia-Pacific economies to respond in 2016 to monetary stimulus, to currency devaluations, as well as to recovery in the U.S. and Europe. Their models show equity markets in the region lack momentum, but offer acceptable value. However, bond markets across the region remain vulnerable.
Looking at the Australian market specifically, Graham Harman, the firm's senior investment strategist based in Sydney, said, "Australian national income numbers are holding up, but with weak commodity prices, a softening housing sector and flat corporate profits, it's hard to get too excited."
Noting that fiscal and monetary policy in Australia currently are somewhat gridlocked, Harman added, "Current data remains mixed rather than downbeat, and we do not expect recession in 2016. But we continue to see housing-related downside risks following a record boom as a watch-point."
Outlook process examines business cycle, valuation and sentiment
Russell Investments' global team of investment strategists determines the outlook for 2016 through a clearly defined process that is based on the building blocks of value, sentiment and business cycle. Through 2016, they expect a balance between concerns about valuations against positive cycle views and also shifts in sentiment between the extremes of overbought and oversold. Their current global market perspectives are as follows:
- Business Cycle: Broadly positive outlook in developed markets and Asia’s middle path
The U.S. economy is expected to continue to grow at an above-trend pace in 2016 with monthly payroll gains averaging 190,000 through 2016 and average hourly earnings growth of 2.5%, which could drive inflation higher. The business cycle outlook for the Eurozone is positive with expectations of GDP growth the same as in 2015, healthy 4% to 8% corporate earnings growth, and supportive fiscal and monetary policy. Across the Asia-Pacific region, there is scant evidence so far of the hoped-for recovery in the Japanese economy, but fears of recession in China and Australia are also not supported by the data. In this middle path, steady growth in India is expected – and in New Zealand at lower levels.
- Valuation: U.S. equities are expensive; Europe cheaper, but neutral; and Japan preferred
U.S. equities appear in their view the most expensive among major developed markets, while Euro-zone equities look fairly valued in an absolute sense, as well as cheap relative to the U.S. In the third quarter of 2015, the outlook for bonds in core Euro-zone economies returned to neutral and peripheral bonds are now following suit. In Asia-Pacific economies, equity markets appear to offer reasonable value. Japan is preferred and is benefiting from good corporate profit growth, a favourable policy backdrop, lower oil and gas prices, as well as a weaker yen. Valuations in China "A" shares have largely unwound from the excesses of mid-2015 and long-term growth prospects look good, but uncertainty remains regarding debt imbalances. In Australia, value is less compelling than it might at first appear because of a thin price-to-earnings discount to global valuations, lack of earnings momentum and stretched payout rates.
- Sentiment: Slightly positive in the U.S. and Eurozone, but muted in Asia
Equity sentiment in the U.S. is slightly positive and fading back to neutral, but short- and medium-term oversold signals have also faded since the selloff in August 2015. Euro-zone price momentum is still neutral but contrarian indicators continue to keep the overall score slightly positive. In Asia-Pacific, sentiment is muted, though it offers some potential for upside, particularly in Japan.
Updated regional exposure forecasts
The strategists also updated their forecasts across global regions and asset classes for 2016, including:
- Asia–Pacific: The team believes equity markets across the region lack momentum but offer acceptable value, while bond markets remain vulnerable. In 2016, they are not looking for more than single-digit equity returns. For the strategists to be more positive on emerging markets in the region, they need to see signs that China’s economy is bottoming, global export demand is picking up, and emerging market currencies and interest rates have adjusted to Fed tightening expectations.
- United States: The strategists continue to have a modest underweight preference for U.S. equities in global portfolios, with the earnings outlook supporting a low- to mid-single-digit total return expectation in 2016. Volatility in U.S. equities and rates should remain somewhat elevated into March when the Fed potentially will provide investors with further clarity on the pace of its hiking cycle.
- Eurozone: The team maintains its overweight position to euro-zone equities, but has shifted to neutral in peripheral bonds alongside their existing neutral position in core government bonds.
- Currency: The team sees 5% upside potential for the trade-weighted U.S. dollar against developed market currencies and 10% against emerging markets. Dollar strength is expected to peak in 2016 as a multi-year period of outperformance starts for emerging market currencies.
- Credit: Corporate credit in their view will be under pressure from rising debt levels and subdued profit growth. Balance sheet quality is deteriorating on the back of increased leverage from buybacks and slowing profits growth, but default rates will stay low through 2016—with the exception of the energy sector. Returns should be positive in 2016, but the upside will be limited.
"The low-return environment is set to tighten its grip in 2016," said Jeff Hussey, Russell Investments' Global Chief Investment Officer. "There is a chance that markets will post surprisingly strong returns but this would be a temporary reprieve at this late stage of the cycle. We see two keys to success in such an investing environment: access to a wide source of investment opportunities and a robust investment process that guides active asset allocations."
For more information, please see the "2016 Annual Global Market Outlook".About Russell Investments Russell Investments, a global asset manager, is one of only a few firms that offers actively managed multi-asset portfolios and services that include advice, investments and implementation. Russell Investments stands with institutional investors, financial advisors and individuals working with their advisors—using the firm’s core capabilities that extend across capital market insights, manager research, asset allocation, portfolio implementation and factor exposures— to help each achieve their desired investment outcomes. Russell Investments has more than AUS$337 billion in assets under management (as of 9/30/2015) and works with more than 2,500 institutional clients, independent distribution partners and individual investors globally. As a consultant to some of the largest pools of capital in the world, Russell Investments has $2.4 trillion in assets under advisement (as of 12/31/2014). The firm has four decades of experience researching and selecting investment managers and meets annually with more than 2,200 managers around the world. Russell Investments also traded more than $1.7 trillion in 2014 through its implementation services business. Headquartered in Seattle, Washington, Russell Investments operates globally, including through its offices in Seattle, New York, London, Paris, Amsterdam, Milan, Dubai, Sydney, Melbourne, Auckland, Seoul, Tokyo, Shanghai, Beijing, Toronto, Chicago and Milwaukee. For more information about how Russell Investments helps to improve financial security for people, visit https://russellinvestments.com/au or follow @Russell_News.
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