A strong US dollar, falling commodity prices and lacklustre earnings growth were all factors that weighed on markets in 2015 and the same is expected in 2016.
However, we believe investors need to be ready to reposition their investments in case there’s a change in direction of one or more of these factors. Higher commodity prices and earnings growth would be positive for emerging markets, as would a weaker dollar.
Within Asia, we are positive on China, negative on Malaysia
We are positive on Japan and Europe. We are cautious on the US and Asia ex-Japan and negative on Emerging Markets outside Asia. Within Asia, we are positive on China, negative on Malaysia.
The Chinese equity market has witnessed a challenging start to the year. Nevertheless, we remain positive, focusing on the new economy sectors including services and the consumer. We are negative on old economy sectors including manufacturing and heavy industry.
In the past, it was challenging for investors to buy into the ‘new China economy’ view as equity indices tracked by funds were dominated by old-economy sectors. However, recent changes to the MSCI index methodology have substantially increased the weight of new economy sectors at the expense of the old economy.
Three key themes
Given the volatile start to equity markets in 2016, the likelihood of sticking with a plan outlined today for the full year is slim.
However, knowing the key themes in the market and understanding the risks and opportunities associated with these should help investors protect and grow their investments.
We think the three themes for the year ahead are:
- The positive effect of modest increases in US interest rates on US banks
- The structural shift towards cloud services and the positive effect this is having on US-listed technology firms
- Continued growth in Mergers & Acquisitions (M&A) activity
Rising rates – positive for US banks
Rising rates having a positive impact on banks can appear counter-intuitive as investors often view higher rates as signalling increased loan defaults and falling demand for credit. While undoubtedly a side effect of higher rates, this usually happens later in the cycle as opposed to early stages of rate increases.
In the early stages, banks are able to widen the spread between what they charge borrowers for loans and what they pay depositors in interest. This wider spread can lead to higher profits.
Growth in cloud services
The growth in cloud services as a driver of earnings in the technology sector emerged as a big theme in 2015 and we expect this to continue. Analysis by Bloomberg highlights only 25 per cent of the USD228 billion available market for cloud services in the US has been tapped so far by technology companies, implying significant future growth for this new industry.
More M&A activity
Global M&A activity reached USD5.7 trillion in 2015, surpassing the prior cycle peak of USD4.9 trillion in 2007. As each cycle brings a new high in M&A, we believe potential for a further increase in 2016 remains. We expect the technology sector to be a prime beneficiary of this trend as US companies put some of their cash held overseas to work.
The risks to watch
We believe watching market risks will be important for preserving and growing the value of investments in 2016. The key risks to keep an eye on include:
- Policy mistakes in the US, China and Europe. This covers an unexpectedly rapid increase in rates by the Federal Reserve, a miscalculation by authorities in China over the appropriate pace of currency weakness, and the migrant crisis in Europe leading to an unexpected political response
- Oil prices are currently low, whereas geo-political tensions in the Middle East have never been higher. Historically, political tensions resulted in a ‘conflict premium’ in oil prices. The market is not factoring this in for now, but could do so in the future
- Earnings disappoint remains a key risk. The S&P500 recorded no growth in earnings in 2015; this year’s consensus expectations are for a 4 per cent increase. The key risk for markets is a failure to achieve on this recovery
So it’s not been the smoothest start to the year for investors, which means being prepared to re-plan investments is just as important as having the right strategy.