Themes and Things for 2016

It’s that time again when we do our best to predict, or more accurately “make an educated guess” on, a couple of themes or trends for the upcoming year.  If you have been following our “Notes” for a while, you know that this has become an annual opportunity for us at Stone Bridge to end up with some egg on our face.  In a recent interview we were asked what we thought about the 2015 investment year.  In a word we responded, “Tough”.  Yep, that about sums it up.   With that said, let’s take a look back at our 2015 predictions and see how we did. 

Our predictions were that energy prices would rebound, that Japan would outperform Europe, and that—even with the Fed raising short-term interest rates—the yield curve would flatten.  To quote the ever popular seventies and eighties musical artist Meatloaf, “two out of three ain’t bad”…unless the one you happened to miss was Energy, and its price move was so negative that it dominated the news and significantly influenced global markets to the down side.  At the time, we thought it was a supply issue that would quickly clear up.  The market seems to fear that the culprit is as much a decline in demand from slowing global GDP.  As a result, market volatility spiked in August, echoes of which have continued to resonate through now. 

So what do we think is in store for equity and bond markets for 2016?  Once again we will look at three areas for this year’s predictions: interest rates, high yield bonds, and the US consumer. 

Prediction #1:  Although Federal Reserve Vice Chair Stanley Fischer has indicated that the Fed will look to raise rates four times in 2016, we, along with many investment professionals, believe that the number of rate increases should be half that.  Our rationale is two fold. One, the Fed is certainly concerned about the global economy and the impact of rate increases on global GDP.  We saw this in action when the Fed delayed an expected September hike on concerns over the potential impact on China’s economy.  For 2016 the early economic data out of China continues to look sluggish at best and will continue to weigh negatively on global GDP.  Two, the strong dollar and low energy prices will keep a lid on inflation.  Low inflation allows the Fed to continue to take a conservative view and relax on raising rates.

Prediction #2:  High yield bonds will be one of the top performing asset classes in 2016.  The price collapse in energy has created significant downward pressure in the high yield bond market. According to Blackrock, a leading asset management and research firm, energy debt represents about 15% of the total high yield bond market.  Most investors who have exposure to energy bonds have it through broadly diversified high yield bond funds and ETFs.  As investors sell these funds to reduce their exposure to energy bonds, they are selling bonds of other companies as well.  Forced selling of these other bonds creates buying opportunities and opportunities for out performance as high yield markets stabilize later in the year.

Prediction #3:  The US consumer will continue to shine in 2016.  Our rational is pretty straightforward here.  As we expect energy prices to stay relatively low and the dollar to remain strong, consumers will continue to benefit from low gas prices and low inflation, which increase their purchasing power.  The continuation of low borrowing costs and solid employment data would be additional tail winds to support consumer confidence.

So there you go.  Only two interest-rate moves, a late year opportunity for high yield bonds, and a strong US consumer to keep the US economy stable.  Three things that may or may not happen, but at least we have some “food” for thought.  You should know by now that we can’t resist an opportunity for a few “eggs”.