Review of 2015, outlook for 2016 – more of the same

Key points

• 2015 has been a messy year for investors as worries about China, emerging countries and the Fed caused volatility and uneven returns across asset classes. Australian shares continued to underperform.

• 2016 is likely to see continued okay but uneven global growth, low inflation & easy monetary conditions. While the US is likely to raise rates gradually, other countries including Australia remain biased to further easing.

• Most growth assets, including shares are likely to trend higher, resulting in reasonable returns. But volatility is likely to remain high as the easy gains are well and truly behind us.

• The main things to keep an eye on are the Fed, China and the ongoing rebalancing of the Australian economy.

 

2015 – a constrained year for investors

2015 has seen another long worry list for investors. Some of these – such as terrorist attacks in Paris and tensions in the South China Sea – have not had a lasting impact on investment markets.

However, worries about deflation, falling commodity prices, fears of an emerging market (EM) crisis led by China and uncertainty around the Fed’s first interest rate hike have had a more lasting impact.

In Australia focus remained on the rebalancing of the economy after the mining boom as well on property bubbles. While it has not been a bad year for investors, overall returns have been constrained.

 

Investment returns for major asset classes

 

Total return %, pre fees and tax	2014 Actual	2015 Actual*	2016 Forecast
Global shares (in Aust dollars)	15.0	14.4	15.0
Global shares (in local currency)	10.0	4.5	9.0
Asian shares (in local currency)	5.8	-5.7	6.0
Emerging mkt shares (local currency)	5.2	-4.7	5.0
Australian shares	5.6	-0.2	7.0
Global bonds (hedged into $A)	10.4	3.5	2.0
Australian bonds	9.8	2.3	2.3
Global listed property securities	28.2	5.8	7.0
Aust listed property trusts	27.0	9.9	7.0
Unlisted non-res property, estimate	8.5	12.0	9.5
Unlisted infrastructure, indicative	12.0	14.0	10.0
Aust residential property, estimate	9.0	10.0	4.0
Cash	2.7	2.1	1.9
Avg balanced super fund, ex fees & tax	8.5	4.0	7.5

^{* Yr to date to Nov. Source: Thomson Reuters, Morningstar, REIA, AMP Capital}

 

2016 – another year of constrained growth

There are good reasons to believe we will simply see a continuation of the constrained uneven global growth that we have been seeing over the last few years.

There are no signs of the economic or financial overheating which usually precedes major economic downturns and no major global bubble in real estate or business investment. Inflation remains low, share markets are not overvalued and global monetary conditions are easy.

If Fed raises rates, it’s likely to be a gradual process reflecting constrained US growth and still low inflation. Monetary easing is set to continue elsewhere, which will also limit the extent of Fed tightening as it puts upwards pressure on the value of the $US. So, apart from a left field shock, it is hard to see what will drive a major global economic downturn at present.

However, it is also hard to see what will drive a sharp acceleration in economic growth. The combination of slower population growth, a more cautious approach to debt and structural problems in the emerging world will keep a lid on global growth.

For Australia, the economy is likely to continue to rebalance away from mining. With a further fall in mining investment, falling national income, a slowing contribution from housing and upwards pressure on bank mortgage rates from increasing capital requirements, further RBA interest rate cuts and a lower $A are likely to be needed.

If this occurs then improving conditions in sectors like consumer spending, tourism, manufacturing and higher education should see GDP growth move up to around 3% by year end.

At the same time inflation is likely to remain benign. The RBA is expected to cut the cash rate to 1.75% early in the year.

 

Implications for investors?

The combination of okay global growth, still low inflation and easy money remains positive for growth assets. But ongoing emerging market uncertainties combined with Fed rate hikes and geopolitical flare ups are likely to cause volatility.

• Global shares will likely trend higher helped by a combination of relatively attractive valuations compared to bonds, continuing easy global monetary conditions and continuing moderate economic growth.

• Australian shares are likely to improve as the drag from slumping resources profits abates, interest rates remain low and growth rebalances away from resources, but will probably continue to lag global shares again as the commodity price headwind remains. Expect the ASX 200 to rise to around 5700 by end 2016.

• Commodity prices may see a bounce from very oversold conditions, but excess supply for many commodities is expected to see them remain in a long term downtrend.

• Very low bond yields point to a soft return potential from sovereign bonds, but it’s hard to get too bearish in a world of too much saving, spare capacity & low inflation.

• Commercial property and infrastructure are likely to continue benefitting from the ongoing search by investors for yield.

• National capital city residential property price gains are expected to slow to around 3-4%, as the heat comes out of the Sydney and Melbourne markets.

• Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

• The downtrend in the $A is likely to continue as the interest rate differential in favour of Australia narrows, commodity prices remain weak and the $A undertakes its usual undershoot of fair value. Expect a fall to around $US0.60.

 

What to watch?

The main things to keep an eye on in 2016 are:

• How aggressively the Fed raises rates – continued low inflation is likely to keep the Fed gradual (as we expect), but a surprise acceleration in inflation would speed it up;

• Whether China continues to avoid a hard landing;

• Whether non-mining investment picks up in Australia – a failure to do so could see more aggressive RBA rate cuts;

• Ongoing geopolitical flare ups, including in the South China Sea; and

• Whether the global economy can finally throw off the worry list and constraints seeing growth perk up.

 

^{Source: Edited extract from AMP Capital.}