Mixed signals for 2016; deflation still the global risk

Investors enter 2016 divided on outlook: economic signals are mixed. The global economy is out of sync; with growth in the UK and US, but a slowdown in the developing world. How should investors position for the year ahead?

Investors who were under-weight in oil, mining and industrials in 2015 might be forgiven for feeling smug as they enter the new year. Away from the index heavyweights – which typically capture more of the global problems – there has been good progress over the last 12 months. UK medium-sized companies, in particular, have delivered some strong performances.

Many once believed that demand for metals would grow for decades to come. But faith in the commodity supercycle has finally been shattered. The new hope is that 2016 might bring some supply cuts in copper, iron ore and oil, to help pricing. Yet, the state of the Chinese economy is far from clear, with limited scope to borrow to build more unproductive infrastructure. The global economy is still growing, but also de-industrialising. Global trade in manufactured goods is weak, and even in the UK, growth is almost entirely based on services.

The US economy leads the rest of the world currently. But in the US stockmarket, the re-rating of online businesses such as Facebook, Amazon, Netflix and Alphabet (Google) has disguised weak performance elsewhere. In 2015 to date, the 10 largest US listed companies have had share price gains; the average of the next 490 has been negative. The major US consumer technology businesses are not only grabbing a bigger share of investor interest, but are disrupting conventional businesses and tax revenues around the world. Investors must think harder in the year ahead about changing business models. There is real uncertainty about the future of some major businesses and brands.

Investors who had faith in the Eurozone recovery – refusing to be unsettled by Greece – have had a good year. The Euro represents a straightjacket for the Eurozone that limits policy options. The currency will break if Germany does not reflate. Fortunately, the latest data shows signs that this process is now underway.

Globally, the disinflationary pattern seems likely to persist. It is triggered by weak productivity growth, resulting from a lack of opportunity for productive investment around the world. There is no sign that capital goods demand is suddenly going to pick-up, making it likely that the global pattern of anaemic growth and low inflation will continue. Investors should focus on shares of businesses with genuine underlying growth and some potential for self-help.

Emerging market currencies remain weak, with the US Dollar moving near 13 year highs. US Dollar strength is linked to the issues of whether inflation will return, and if emerging economies will face credit problems. With low oil and commodity prices, growth in the supply of Dollars globally has slowed. This impacts emerging market borrowing, which has in the past been helped by an easy supply of cheap Dollars. Rising US interest rates may exacerbate global disinflation.

Despite the Bank of England talking of a rate rise, there is little sign that UK inflation is progressing towards its 2% target. There are some hot spots in the British economy such as buy-to-let properties, but overall insufficient to merit Bank intervention in the near future. Returns on cash deposits and bonds are likely to remain very low, increasing the attraction of equities that offer growth and growing dividends. Defensive sectors such as healthcare and tobacco, could find a bigger role in portfolios – particularly if there are dividend cuts in cyclical sectors. The UK market may also get a boost from bids and mergers in the coming year.

Investors are nervous, and underestimate the determination of politicians to stimulate growth, resolve international frictions and stabilise the global economy. Investors should structure their assets to ensure that headlines and short term anxiety do not trigger panic. Upside could come from good use of policy tools in Europe, combined with continued US growth. The boost to global stockmarkets from supportive central bank policies could have much further to run.
A version of this article was published in Personal Finance in The Herald on January 2 2016.

Disclosure: The opinions expressed in this article are my own, and may not represent the views of any firm or entity with which I am affiliated. The information presented in this article has been obtained from sources believed to be reliable, however, I make no representation as to their accuracy or completeness and accepts no liability for loss arising from the use of the material. Articles and information do not represent investment advice. I am a manager of actively invested equity funds. At the time of publication, SVM clients had holdings in Alphabet (Google).
Image credit: Some rights reserved. Published on behavioural-investing.org January 4 2016

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