2016's biggest market-moving factors for Europe and the US
14th January 2016 13:10
by Heather Connon from interactive investor
A panel of investment experts explores the complex web of economic and political developments likely to determine the fortunes of European and US equity markets in 2016.
Europe
European markets are "like a fretful spaniel puppy: they take fright all the time, but are still moving onwards", according to Stephen Macklow-Smith, manager of the . The question is, will this be the year they settle down and mature, or will the optimists end up being bitten again?
Our experts agree that Europe has been among the last to join the global recovery party - largely, says Jeremy Lawson, senior international economist at Standard Life, "because of the policy mistakes made in the past few years". He adds: "Fiscal and monetary policy has been too tight, and there has not been enough reform."
Now, however, Mario Draghi, president of the European Central Bank (ECB), has pledged to "take the necessary actions", an echo of the commitment to "do whatever it takes" to engineer recovery that he made in 2011. As Paul Niven, manager of the , points out, Draghi didn't actually have to do much in 2011, as his words alone reassured the markets.
'There is a lot of political risk - for example, in the anger over refugees.'Whether they will have the same impact this time remains to be seen. While the consensus is for further easing, there are still voices at the bank resisting the stimulus programme. Draghi is committed to more asset purchases and is pushing a trend already in place. The ECB is signalling that it will do more in future.
For Lawson, the key risks are that easing will not be enough to get inflation back up to target, European governments will fail to deal with the issues of migration and refugees, and the pace of further institutional reform will be too slow. He says: "There is a lot of political risk - for example, in the anger over refugees. It is still an imperfect union. How will Europe react to the next shock, wherever that comes from?"
European markets healthier than US
On stockmarkets, there is general agreement that Europe is looking in better shape than the US. Macklow-Smith says: "We still think the market can advance this year, fed by the knowledge that companies are doing reasonably well - especially domestically oriented growth companies. Valuations are still attractive. Earnings should turn out to have risen by 6 or 7% in 2015 and that should increase to 8 or 9% in 2016 and 2017."
'Years of austerity, deleveraging, ECB regulatory pressure and profound structural reform have created a European financial system that is much more robust.'He backs this claim by pointing to a recovery in consumer confidence - at a 15-year high in Italy, a 13-year high in Spain and a post-crisis high in France - and a fall in unemployment from its 2013 peak.
"We can find plenty of opportunities in retail and consumer services. There is still a lot of value in telecoms and some areas of the media. We are underweight energy and materials. Their valuations are OK, but we have yet to see a floor in their profits," he adds.
Matt Siddle, manager of the fund, agrees: "There are plenty of positives for Europe at the moment. Falling oil prices are helpful for consumers and euro weakness is good for corporate competitiveness, while the falling cost of debt and the rising availability of finance and liquidity have provided a supportive framework across the board."
Recovery plans are working
Stephanie Butcher, European equities fund manager at Invesco Perpetual, thinks there is plenty of evidence that the actions already taken by the ECB are working. "Years of austerity, deleveraging, ECB regulatory pressure and, in some cases, profound structural reform have created a scenario where the European financial system is much more robust than it was five years ago," she says.
"Policy is clearly stimulatory, with less austerity, lower currency exchange rates, a higher capital base for the European banking system, lower bond yields and hence funding costs, and, of course, a huge supply of liquidity provided by a central bank that has promised to 'do whatever it takes'.
'The financial sector has begun to show evidence over the course of 2015 that earnings are recovering from the cycle lows.'"Add to this the effects of a lower oil price on a net oil-importing region, and one should see signs of life in the European economy."
While global consumer goods and healthcare companies have been go-to purchases among European stocks in recent years, Butcher thinks more domestic-oriented and cyclical stocks could now come to the fore.
She says: "Domestic Europe is no longer a no-go area in our view. Given that emerging markets are facing challenges of their own, earnings growth and upside surprise is, we believe, far more likely to come from depressed European financials and domestic cyclicals than from global defensives already delivering earnings well above their 2007 peak.
"The financial sector has begun to show evidence over the course of 2015 that earnings are recovering from the cycle lows. Domestic cyclicals such as media, travel and food retail show similarly encouraging signs. We believe these trends will continue into 2016."
The US
No prizes for guessing the key feature that will shape US fortunes in 2016: the impact on the economy and stockmarkets of the US Federal Reserve gradually returning to a normal monetary policy. Niven says: "2016 is clearly going to be a pivotal year. We are likely to see a divergence in policy between US Federal Reserve tightening and continued easing by the Bank of Japan and the European Central Bank."
He hopes this will mean pundits finally get their forecasts right. "For the past five years, people have been predicting growth increases, an increase in trade, commodities flat to increasing, deflation moderating," he says. "But in each of these years, we have been disappointed. We have ended up withan anaemic, though positive, recovery.
"The same is being said again for 2016: global growth will accelerate and inflationary pressures increase. But we should not forget that expectations have been disappointed each year." However, he adds: "There is every chance that, over the next 12-18 months, deflationary pressures will erode as US interest rates increase and bond yields rise.
"Labour markets in the US and UK are seeing increasing pressure for wage rises, so inflation may be on the turn."
Time to be wary
For those in the right stocks and sectors, the US has been a great place to invest. But Wouter Volckaert, manager of , thinks it is time to be a bit wary. "It might be too early to be outright bearish on the market going into 2016, but we would suggest it's too late to be bullish.
"The S&P 500 has delivered a total return of nearly 200% since the lows of March 2009, mostly generated by expansion on the back of loose monetary policy. Low interest rates and quantitative easing have created a wealth transfer from nonowners of assets to owners.
'The key is to be sector- and even stock-specific.'"Equity valuations could continue to move up on the back of 'Tina' - the acronym for 'there is no alternative'. Investors who want to put cash to work increasingly turn to equities, especially now that fixed income is losing its appeal in the face of imminent rate rises. But the impact of real fundamentals on valuations will increase going forward."
Fiona Harris, investment specialist at , thinks valuations still look reasonable but adds: "Expect the unexpected. We saw what could happen in August and September in the stockmarket sell-off . The key is to be sector- and even stock-specific."
She points out that, while the S&P 500 was flat last year [2015], half of it rose by more than 15% and half fell by a similar amount. "There are pockets of cheapness - for example insurers trade on just 10 times earnings. , which we own in a lot of our portfolios, is a great company with a great franchise and business model, but it trades on just 11 times."
Niven says: "US markets have been very focused on growth. The question is, will they switch to value? Growth has outperformed significantly and value has underperformed. Even with an interest rate rise on the horizon, growth is still scarce globally, so growth stocks have been bid up.
"Normally, when interest rates start tightening, there is a switch from value to growth. Will we still get that shift? I have no strong view, so we are still running a diversified portfolio."
Macro policy crucial
Macroeconomic policy will be crucial in 2016. Lawson says: "The US outlook is set to be shaped by the impact of the Fed's monetary policy and the ability of the economy to absorb higher rates. That in turn depends on the extent of dollar appreciation and the conundrum over wages.
"You need wages and productivity to rise, so that the economy can absorb the impact of higher interest rates. If it does not, there will be weakness."
'Normally, when interest rates start tightening, there is a switch from value to growth. Will we still get that shift?'Angel Agudo, manager of the fund, is positive about the country. "The US appears to be a bright spot, despite the recent uncertainties surrounding the global economy. The US economy remains in good shape and should continue to improve at a moderate pace until the end of the year," he says.
"Growth is likely to be supported by labour market progress (although at a slower rate), a consumption rebound helped by an improvement in wages, the strength of the services sector, and improving activity in housing and construction-related sectors.
"Going into 2016, consumption-led growth and innovation across sectors will be key factors that could help the US economy continue to grow."
Agudo thinks the stockmarket could struggle this year, as wage pressure combines with the prospect of a stronger dollar as interest rates rise. But he says: "The return of market volatility and subsequent stock correction means I am finding more interesting opportunities than a year ago."
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.