23 Dec 2015 | Author: | No comments yet »

A Brighter Outlook for 2016.

2015 has been a year of waiting, worrying and sideways markets. In particular, while participants in the Fed’s December meeting expected a gradual 1% rise in the federal funds rate in both 2016 and 2017, futures markets are only pricing in tightening at half that pace. Moreover, despite the market’s skepticism, we believe the Fed will follow through on its projection of a further 1% increase in short-term rates next year. Our confidence in this has been boosted by three important events in recent weeks, namely, lower oil prices which should help consumers, fiscal agreements in Washington that should boost government spending and incentivize greater capital spending, and the Fed rate hike itself, which should add to consumer interest income more than consumer interest expense. This sharp decline in unemployment in response to modest GDP growth has been due to slower productivity growth and a decline the labor force participation which we expect to persist, causing the unemployment rate to fall to close to 4% by the end of 2016, far below the 4.7% rate that the Fed projects.

However, with some heavy-handed intervention, the Chinese government has succeeded in stabilizing the stock market and, after a small devaluation, the PBOC has halted further renminbi declines. The collapse in oil prices in late 2014 was due to three factors: a slowdown in global demand, a surge in U.S. production and a decision by OPEC to maintain market share rather than cut production. Because of this, it is now expected that global oil inventories will continue to rise in 2016, although more slowly, postponing any significant rebound in prices, with a similar story playing out in other major commodity sectors. U.S. high-yield bonds may offer more opportunities however, outside of the energy and materials space, in an environment of now relatively high credit spreads and good U.S. economic growth prospects. It’s also worth noting that European high yield has much less energy exposure and vulnerability to central bank tightening than high yield in the U.S.

EM stocks are now quite cheap from a valuation perspective while European earnings should continue to recover in line with an improving European economy.

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