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
SEATTLE, January 6, 2016
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 aging, 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' favored 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 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.
For the strategists to be more positive on emerging markets, 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.
"2016 is likely to be a year of moderation: moderate growth, a moderate Fed and moderate asset-class returns," said Paul Eitelman, investment strategist, North America. "The main risks to this scenario are that U.S. growth weakens or a slowdown in emerging markets flows into developed economies. On the other hand, if growth is too strong, there is a risk of inflation pressures and more aggressive Fed action. Key indicators for investors to watch will be whether U.S. non-farm payrolls and S&P 500® Index earnings per share grow in line with expectations, and if emerging market exports move from contraction to expansion."
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 business cycle, value and sentiment. Through 2016 they expect to balance 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% that 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 Eurozone 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 Eurozone 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 favorable 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 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 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. Eurozone 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:
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.
- 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.
The team maintains its overweight position to Eurozone equities, but has shifted to neutral in peripheral bonds alongside their existing neutral position in core government bonds.
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.
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 profit 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.
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