Global investment trends and risks
Most investors can barely make two good calls for the past year.
In 2015, the major asset classes almost maintained the general trend since the stock bull market began in March 2009, but now there are clear signs of market weakness. Although looking back, some major trends are obvious: weak oil prices, depreciation of the euro, appreciation of the U.S. dollar, sharp depreciation of emerging market currencies-but for the sharp reversal shown in these trends, many macro investors have not been able to immediately Hold on.
The global stock return rate (calculated in local currency) is about 2%[1], which is lower than in recent years. In dollar terms, the rate of return is slightly negative. The market peak reached in May 2015 could not be reached again. The top may be forming, but there are currently few signs that a large-scale bear market trend has begun.
The government bond rate of return was about 1%, breaking the prevailing forecast of a trend reversal. The yield was almost flat for the whole of last year. Commodity prices fell by 33%, continuing the slump that began in mid-2014, and finally driving the credit market to fall. For example, the return of US high-yield securities in 2015 was -9%. Emerging markets (and, confusingly, China’s stock market is the exception and the best-performing major stock market) have also been affected by the collapse in commodities, and the overall performance of emerging market stocks, credit and foreign exchange assets continues to underperform that of developed markets.
Overall, the magic combination of moderate GDP growth and extremely loose monetary conditions continues to work in developed markets. However, the overall return on the global asset market (bonds and stocks, calculated in local currency, with equal weights) is only about 1.5%, which shows that some of the magic is gradually disappearing.
Looking ahead, the return on assets in 2016 will at best be comparable to last year's low level. At least this is the overwhelming core consensus of mainstream forecasting agencies. But as the bull market matures, we will soon experience a sharp drop in asset prices in a certain year, which seems inevitable. Will 2016 be that year?
The 2016 macro themes confirmed by some major forecasting agencies are summarized below. With a few exceptions (notably Citigroup, which expects a global recession in 2016), these themes have gained widespread acceptance and become more and more familiar. This is not a new phenomenon: although many themes are clearly revealed in advance, they will come into play over time.
Global GDP growth is expected to rise slightly from its low in mid-2015, but investors are now aware of the substantial decline in potential productivity growth since the financial crisis, and they no longer expect the pace of recovery to accelerate significantly.
Global output levels will still be below trend levels, both in developed and emerging markets, so potential inflation should not rise anytime soon. However, as commodity prices are expected to stabilize, forecasting agencies believe that the overall inflation rate will rise, which will drive bond yields upward.
As for the central bank, there are two major themes that almost everyone agrees with. In general, global monetary conditions are expected to remain extremely accommodative. However, it is expected that the policies of the most cutting-edge central banks (the Federal Reserve (Fed), and possibly the Bank of England) and other central banks will diverge further. The resulting appreciation of the U.S. dollar is an old and successful theme, but it is still much loved.
Another widely expected theme is that the pace of growth in emerging markets will still be difficult, although almost no one currently predicts that China will experience a hard landing. Many people mentioned the possibility of credit deleveraging in emerging markets, but few predicted that this effect would be strong enough to trigger a severe global downturn.
The economic background outlined by these themes will be slightly beneficial to the return on assets, somewhat similar to 2015. But downside risks may make this year's performance much worse. Three risks seem to be particularly worrying:
1. The more unfriendly Federal Reserve
Investors seem to be very indifferent to this risk. They believe that prolonged stagnation (this theme is still generally accepted) will hinder the Fed's pace of raising interest rates. But is the relevant risk balance correctly reflected in the market price? The Federal Open Market Committee (FOMC) has reminded us many times that it is expected to announce four 25-basis-point interest rate hikes in 2016, while the market forecasts only two. If the Fed announces its next interest rate hike in March this year (skip the January meeting), the market may suddenly wake up and pay attention to the possible pace of interest rate hikes.
The fundamental problem is that the FOMC is far more skeptical than the market for the assumption of long-term stagnation. The committee is more convinced that in the next one or two years, economic unfavorable factors will weaken, enabling them to raise interest rates to a level consistent with the gradually rising equilibrium interest rate. If, as they predicted, core inflation rises in the next few months, then they will believe this view even more. This will mean that both the bond and stock markets will experience more ups and downs.
2. RMB depreciation
This kind of risk caused market panic in August 2015, especially when the Fed initiated an interest rate hike cycle. Investors worry that while the U.S. monetary policy turns, China is determined to export deflation through the devaluation of the renminbi. This concern is enough to trigger a strong earthquake. At the beginning of the new year, investors are more convinced that they understand China's new exchange rate strategy. This seems to be manifested in the fact that the renminbi has maintained greater flexibility in referring to the (possibly) rising dollar, but the effective exchange rate of the renminbi against a basket of currencies is basically stable. Looking back, China seems to have been following this policy throughout 2015.
The People's Bank of China now convinces the market that it has no intention of lowering the effective exchange rate of the renminbi to a level far from the stable range that it operated last year. However, deflation is still widespread in China's manufacturing industry, and overcapacity is far from eliminated. A sharp depreciation of the renminbi will only be the last option. But this represents a huge tail risk, which will cause the final fatal blow to the stock bull market.
3. Credit crisis in emerging economies
Credit growth in the entire emerging world is now slowing, and the cessation phase of the credit cycle may be quite long. JPMorgan economists estimate that in the next three years, credit deleveraging may cause the GDP growth rate of emerging markets to decline by 2 to 3 percentage points. If there is a severe financial confidence crisis, the decline may be even greater. This is enough to slow the global GDP growth rate by 1 to 1.5 percentage points. In the worst case, a global recession is also possible.
After 2008, macroeconomists were shocked by the severity and persistence of the contraction effect produced by the bursting of the credit bubble in the developed world. The relatively reassuring assumptions made now to form the core economic and market forecasts for 2016 may easily come to nothing because of similar crises in emerging markets.