With the global economic expansion entering into a more mature phase over the past year, the fallout from the strong dollar has plagued financial markets.
Global growth for 2015 is estimated at only 3 per cent, which would be the worst showing since the 2008/09 financial crisis. This reflects a mix of factors, not only the dollar but also plunging commodity prices, weak pricing power for many companies, sluggish global trade growth and excess capacity in many industries, all eroding corporate profitability. Global equities were modestly positive in sterling terms during 2015, with a strong showing in Japan helping to lift the global average. By contrast, European indices were up only in local currency terms; for sterling-based investors, returns were negative and almost as bad as the UK markets.
For 2016, I anticipate only a modest rebound in global growth to 3.25 per cent; after all, this remains a world of low numbers, whether in terms of GDP, CPI, interest rates, bond or dividend yields – creating considerable challenges for policy makers and investors. I expect most emerging market economies will manage to stem their economic slide, but still face stiff headwinds from weak global trade growth and low commodity prices. By contrast, the outlook for developed markets is more favourable for 2016. Modest fiscal support in the US, Japan and Europe should help lift activity.
On this basis, this year looks set to repeat the same themes as 2015: EM under-performance relative to DM, and better returns only if currency risks can be hedged.
However, investors will need to address head-on potentially more challenging complications from realised, divergent central bank policies. We are no longer anticipating the first US rate hike; the tightening has begun. Would higher US rates further support another round of significant US dollar appreciation? If the answer is yes, then commodity prices will likely suffer yet another hard year, as will the earnings of resource-linked US and UK corporates. The translation effect of foreign profits into US dollars would likewise be lower, while import competition would more seriously erode domestic margins. The UK economy could face similar challenges in 2016, as we anticipate the Bank of England to begin to normalise rates as long as there is sufficient wages pressure to justify a policy tightening.
Secondly, developments at other major central banks – in particular China, Japan, and Europe (the ECB) – could also channel investors into, or out of, stock, corporate bond and commercial real estate markets. The ‘two-speed’ economy remains a key investment theme: there is considerable strength in terms of consumer spending and business services, partly helped by improving employment conditions but also the beneficial effects of lower commodity prices in general – oil in particular. The converse is the weakness of much of the manufacturing sector in these countries, especially firms exposed to commodity price pressures or weak export markets. As a result, we see a continued need for loose monetary policy, and where possible fiscal policy, in all three regions. This can help with economic rebalancing, in the case of China; an eventual exit from deflation, in the case of Japan; and slowly resolving the sovereign debt crisis, in the case of Europe. In particular, the success of Chinese policymaking matters enormously for a range of developed and emerging market economies – as shown by the sensitivity of asset prices in many countries to stimulus or reform announcements in China. Conversely, too much easing from any of the central banks, whether in emerging or developed markets, could weaken their currencies more substantially, further stressing the balance sheets of weak economies and pushing the US dollar even higher.