 | 1. s&p 500: the ultimate “anti-credit play.” the stard poor’s 500 index is expected to reach 2200 by the end of next year, beginning a slow trajectory toward 3500 in 10 years. gains in the year ahead imply a 5 percent return for the s&p, roughly equivalent to earnings growth or a 2016 eps forecast of $125. with credit-sensitive investments the biggest risk in 2016, the s&p 500 could be viewed as the ultimate anti-credit play: large, liquid stocks with healthy balance sheets above average cash balances.
2. modest u.s. global economic growth. global gdp is forecast to grow by 3.4 percent, up from 3.1 percent in 2015, which is slightly below trend. growth of about 0.5 percent faster than trend is forecast for europe, the u.s. japan. in the u.s., gdp growth is expected to remain steady at 2.5 percent next year as a solid labor market offsets weak productivity growth.
3. gentle rise in inflation. globally, headline inflation is expected to inch up to 2.8 percent as the effects of commodities price s begin to fade. underlying inflation should remain stable, with key differences between developed emerging markets. by year-end, u.s. unemployment should reach 4.5 percent, causing a gentle rise in inflation next year, including wage price inflation at 0.5 percent 0.2 percent respectively. emerging market inflation could decelerate to 3.8 percent, down from 4.3 percent in 2015. the strongest el niño weather pattern in 18 years represents a potential upside risk to inflation, particularly in asia latin america.
4. start of emerging markets recovery. for the first time since 2010, average annual growth in emerging markets should begin rising to 4.3 percent in 2016 from 4.0 percent in 2015. excluding china, growth should pick up to 3.1 percent in 2016 from 2.6 percent in 2015. about three-quarters of emerging market economies could show signs of recovery by the middle of 2016, whereas brazil could contract further to -3.5 percent as it struggles to climb out of recession. investment likely will become the key driver of the emerging market recovery. asset price returns of roughly 2.7 percent for external sovereign debt, 2.5 to 3.5 percent for emerging market corporate debt, 1.0 percent for local currency debt are expected in 2016.
5. interest rates: up from zero. the federal reserve is expected to carefully calibrate a rate hike over the next two years, with a 0.25 percent hike this month three or four 0.25 percent increases in each of the next two years. meanwhile, further quantitative easing is expected in europe japan a mixed bag of policies in the rest of the world. u. s. 10-year treasuries could reach 2.65 percent, the dollar should remain strong, rising by 4 percent to 6 percent. the confluence of modestly higher rates, a fed liftoff, more regulatory pressures will likely keep liquidity risks in bond markets at the forefront.
6. divergent monetary policies: u.s. china go separate ways. with the federal reserve set to raise rates the people’s bank of china likely cutting rates, divergent monetary policies will shape the rates currency markets in 2016. more weakness in the renminbi (rmb) is expected, with the currency depreciating over 7 percent against the u.s. dollar in 2016. this could have negative effect spillovers on emerging asian currencies commodity markets.
7. commodities under pressure. a strong u.s. dollar restrained global growth could create downward near-term pressures on commodity prices – not just in metals, but also in energy grains. overall, commodity returns could be flat to down by as much as 3.7 percent next year. oil balances are set to improve in the second half of the year, with the combination of global dem lower non-opec output potentially pushing crude oil back up to $55 a barrel. meanwhile, natural gas dem should remain robust, with the spread between gas crude oil widening. base metals will likely stay soft, with gold continuing to struggle as the dollar strengthens rates rise.
8. credit is complicated. fundamental trends in the global credit markets are divergent, there appears to be no single global credit cycle. optimism is highest for u.s. high grade, with 3 to 4 percent of excess returns expected next year. the bear market for u.s. high yield continues, with expected total return losses of 2 to 3 percent. persistent yield differentials between u.s. global corporate bonds are expected to force global investors into the u.s. market, with potential returns as high as 6 to 7 percent, 30-year corporate bonds could deliver equity-like returns in 2016. it could be a tough year for credit in emerging markets, with stark divergence in returns from nation to nation. still, the overall forecast for emerging market credit is positive, with a 4.0 percent total return for high yield 2.5 percent for investment grade.
9. global investment strategy. global stocks are expected to rise by 4 percent to 7 percent in the next year, with equity markets in japan (strength across the board), europe (banks) the united states (high-quality cyclicals) among the stouts. bofaml’s asset allocation calls are long u.s. dollar, volatility real estate short commodities other credit sensitivities stocks over bonds developed markets over emerging markets investment-grade over high-yield bonds. with main street bulls wall street risks, the best ways to invest could be to buy what the middle class buys: mass retailers, regional banks investment grade bonds.
10.u.s. housing recovery continues. further expansion of the u.s. housing market is forecast for 2016, with housing starts of 1.275 million, reflecting a recovery in household formation. existing home sales could increase by 5 percent in 2016, while new home sales see a more robust 10 percent growth rate. home price appreciation could slow in 2016, with prices up by only 1 percent, a reflection of home price overvaluation relative to income. though the rise in interest rates poses some risk to the u.s. housing recovery, the fed’s go-slow approach should prevent a painful rise in mortgage rates. long term, there are signs of a structural shift in the housing market toward renting over home ownership, , in turn, an increase in multi-family housing construction.
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