2016 INVESTMENT OUTLOOK

Transcription

1 2016 INVESTMENT OUTLOOK The U.S. economy maintained its slow and steady rate of growth in 2015, much as it has since the end of the Great Recession in Modest improvement in the housing market and favorable news on the job front helped keep it on track. Global economies faced more headwinds, but most of the world continues to experience modest growth as well. By year s end, stocks did not experience a dramatic change from the start of the year, but there was significant volatility experienced at various times. Bond investors found themselves in a holding pattern, waiting for the Federal Reserve to begin raising the short-term interest rates for the first time since While the underlying numbers may not show it, 2015 was an active year in the stock and bond markets. Early in the year, as the U.S. economy temporarily slowed due to winter weather issues, bond yields declined significantly. As the economy improved, bond yields gradually rose to slightly higher levels than where they began the year. Stocks went through periods of significant volatility as well, particularly in August and September when concerns about global economic growth emerged due to challenges facing China. In the end, U.S. stocks posted lackluster returns for the year. After a sluggish start, the U.S. economy managed to maintain the pace of modest growth that has become typical in recent years. The level of economic activity both in the United States and overseas was not sufficient to spur any dramatic moves by the Federal Reserve (Fed), as short-term interest rates remained near the zero percent level. The unemployment rate dipped to 5 percent and job growth remained solid, keeping consumers in a position to bolster the economy, even as business investment proved to be disappointing and government spending remained subdued. Housing activity showed improvement, most notably in a handful of select markets around the country. In overseas markets, increasing focus turned to China. While its economy continues to grow at a rapid pace (compared to most parts of the world), the rate of growth has slowed as China s economy goes through a transitional period. Developed markets in Europe and Japan are still dealing with issues that date back to the financial crisis and growth has been below that of the United States. International stocks started the year on a strong note, but performance subsided in the middle of the year when concerns about China s economic growing pains came to the surface. Investment products and services are: NOT A DEPOSIT NOT FDIC INSURED MAY LOSE VALUE NOT BANK GUARANTEED NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY [ 1 ] Important disclosures provided on page 8.

2 GLOBAL ECONOMIC VIEWS United States: We anticipate solid growth through 2016, averaging 2 percent to 3 percent. Improving employment, strong consumer balance sheets and likely rising incomes underpin the U.S. economy. Net exports may be the primary drag on the economy due to the weight of a stronger U.S. dollar on trade. Headline inflation should normalize from its recent low levels, averaging 2 percent gains during the year. Wages and home prices likely rise and commodity prices may halt their declines, but supply overhangs remain a headwind. Europe: European Central Bank quantitative easing measures likely continue to support economic growth, despite the headwind from bank deleveraging. Growth is unlikely to exceed 2 percent due to deleveraging and demographic headwinds. Deflation risks likely continue to plague Europe, but inflation should normalize on more stable food and energy prices. Japan: Quantitative easing is likely to continue in 2016, but may be reaching the limits of efficacy. Structural reforms, such as minimum wage gains, are needed to lift potential gross domestic product (GDP) growth. Growth likely averages just 1 percent for China: Growth is likely to slow toward the government s long-term target of 6.5 percent year over year. Key government initiatives appear to include expanding consumption in the economy and liberalizing economic institutions, including a free-floating currency and wider equity ownership. Easier monetary policy and a weakening yuan will act as supports to economic growth. Other global economies: The world is experiencing greater economic divergence, with Russia and Brazil mired in recession while growth in India remains strong. Brazil is likely to remain in recession, with higher interest rates and high inflation. Growth in Russia should improve on a weaker currency. India is well positioned, with lower interest rates to continue its growth story is shaping up to look much like 2015 as we assess prospects for the U.S. economy, according to Rob Haworth, senior investment strategist. As has been the case for some time, the key to ongoing growth is consumer spending, says Rob. Most governments remain on the sideline and businesses are only investing in their growth at a modest rate. One key to the level of consumer spending will be if wages are able to rise at a rate that outpaces inflation. With the unemployment rate dropping to 5 percent, the pressure for wages to increase is likely to be greater in 2016, says Rob. The economies of Europe and Japan are likely to see more modest growth than the United States in the coming year. Bank deleveraging is still in place, and that limits growth prospects for those regions, Rob believes. The weaker euro (against the dollar) is helping European companies boost exports. Rob points out that Japan has experienced two recessions in the past two years. Growth in Japan is even more muted than in Europe. Among emerging markets, he notes that China s economy is slowing, but still growing at a rapid pace compared to most parts of the world. He cites a two-pronged story in other emerging markets. Commoditydriven economies are struggling given low prices for oil and metals while commodity-consuming countries are benefiting from this trend. Robert L. Haworth, CFA Senior Investment Strategist [ 2 ] Important disclosures provided on page 8.

3 EQUITY MARKET VIEWS Performance of the equity markets in 2015 can be described as lackluster, yet remarkably resilient, says Terry Sandven, chief equity strategist. Various factors have elevated the risk profile of equities, according to Terry, including policy changes by the Federal Reserve and corporate profits being affected by the stronger dollar and overall sluggish global growth. Yet Terry believes equities remain well positioned in 2016, though a more selective approach may be required. Attractive opportunities can be found in companies that perform well in a slow-growth, lowinflation environment. Terry sees some of the best potential in the Technology, Consumer Discretionary, Healthcare, Financial and Industrial sectors. Firms that cater to a global consumer, participate in e-commerce, cloud computing or anywhere, anytime connectivity seem particularly well positioned, says Terry. He also sees reasonable prospects among firms that cater to an aging population and are involved with selfdirected healthcare solutions. Terry D. Sandven Chief Equity Strategist U.S. equities are entering 2016 and approaching the seven-year bull market anniversary with macro and fundamental backdrops supportive of still higher prices. Inflation remains constrained, supporting price-earnings multiples near current levels. Earnings are increasing, albeit at a moderating pace. Valuations, while elevated, are short of extremes. Interest rates are low, adding to the relative attractiveness of equities. Sentiment is generally positive, bolstered by firming wages, a stable housing market, low core inflation, low energy prices and rising consumer net worth. And, select equities offer both income and appreciation potential, with approximately 40 percent of S&P 500 companies offering dividends yielding above the 10-year Treasury yield. Outside of the United States, we expect to see continued divergence in economic growth, with commodity-importing economies outpacing commodity producers in In Europe and Japan, the combination of low oil prices, competitive currency values, reasonable equity valuations and continued monetary policy stimulus should be supportive for foreign developed equities. Policymakers in China are committed to supporting domestic demand as the country continues to transition from an investment- to consumption-led economy. While we expect modest gains broadly across foreign equities in 2016, indications of rising credit stress in certain emerging economies suggest that developed markets may continue to outperform emerging market equities. Despite a favorable outlook, the risk profile for equities is elevated, suggesting that increased volatility and muted returns are apt to be hallmarks of 2016 performance. The slow pace of global growth, geopolitical instability and resurgence of terrorism, shift in Fed policy, elevated valuations and the potential negative effects that higher interest rates and firming wages may have on margins and earnings are among items that give us reason for pause. Our price target for the S&P 500 in 2016 is 2,225, approximately 10 percent above 2015 levels. Our grind higher thesis is anchored on the belief that the pace of future Fed rate hikes, wage gains and core inflation will be moderate, effectively paving the way for cyclical sectors and companies with pricing power to gain market share and be among the best performers in the new year. [ 3 ] Important disclosures provided on page 8.

4 FIXED INCOME MARKET VIEWS We believe the Federal Open Market Committee s (FOMC) trajectory of policy rate normalization in 2016 will be quite shallow relative to previous cycles. Any future increases in the fed funds rate will be driven by the data dependency nature of the FOMC. As such, we would expect increased volatility around economic data releases, most acutely around inflation and labor market data. We expect the Fed to execute three separate 25 basis point increases in the policy rate next year. As a result, the fed funds rate should be near 1 percent by the end of We expect the yield curve to continue to flatten. Policy rate normalization will put a disproportionate amount of pressure on the short end of the curve relative to the long end. There are three headwinds to substantially higher long-term rates: diverging central bank policies should increase foreign interest in the U.S. debt market, many corporate pension plans have approached fully funded status and have begun to reduce equity positions in favor of longer-dated debt, and domestic demographics via the retiring baby boomers have led to increased interest in U.S. bonds. As a result, we expect the 10-year Treasury to end the year between 2.75 percent to 3 percent and the 30-year Treasury to be between 3.5 percent to 3.75 percent at the end of Despite experiencing a spread widening in 2015, we expect high yield debt to outperform the other fixed income market sectors in Most of the stress in high yield is concentrated in energy and mining-related sectors. Outside of those two sectors, the fundamentals remain favorable, with interest coverage at record highs. Although we expect default rates to climb modestly in 2016, they will still remain far below long-term averages. In addition, the higher coupons of this sector will provide some offset to potential price declines as the Fed begins to normalize the policy rate. Historically, high yield is one of the most attractive fixed income sectors during a rise in the fed funds rate. We remain wary of non-dollar denominated debt. We expect the Bank of Japan and the European Central Bank to remain accommodative in The effect of diverging central bank policies and the associated interest rate differentials should lead to modest dollar strength. As a result, we would expect any price appreciation of foreign-denominated debt to be eclipsed by U.S. dollar strength, leading to negative performance for U.S. investors in nondollar denominated bonds. Much of the focus of the bond market in the past year was on the Federal Reserve as investors waited for the Fed to begin raising interest rates. We saw some substantial dips and inclines in 2015 while waiting for the Fed to make its move, says Jennifer Vail, head of fixed income research. But in the end, there was not a lot of change, though yields are beginning to drift higher, toward more normalized levels. Expected interest rate hikes by the Fed will likely remain the primary focus in the coming year, says Jennifer. Because the pace of rate increases will be modest, the bond market should be able to digest these moves fairly well and the downward pressure on bond prices will be limited. Jennifer believes Treasury securities may face the most challenges while investment grade credit will be somewhat neutral. High yield and emerging market debt, with a higher coupon, should be able to maintain price levels in a rising rate environment in 2016, says Jennifer. Jennifer L. Vail Head of Fixed Income Research [ 4 ] Important disclosures provided on page 8.

5 REAL ESTATE MARKET VIEWS It was a mixed year for the housing market, although the general trend was favorable, according to Ed Cowling, director of Specialty Assets. The trends were not consistently positive from month to month, but the environment continues to improve into In the end, existing and new home sales were at the best levels since 2008, though still below the peak levels reached three years earlier. The multifamily market has been very strong in recent years and will likely remain that way, says Ed. The continued strength of the commercial real estate market is broadening, according to Ed. Large markets have already been doing very well. Now that s spread to second tier markets such as Nashville, Austin, Dallas, Denver, Seattle and Portland. These are cities where new jobs are being created and the demand for commercial space is on the rise. Edgar W. Cowling, Jr., CCIM Director of Specialty Assets We believe the housing recovery continues at a demonstrated pace, with correlation to the overall economy, job creation, wage growth, household formation levels and consumer and builder confidence. Existing home sales continue the advancement, and we believe the 2016 outlook is positive. New home sales may show volatility month to month, yet will continue to pull out of recession lows. The inventory of both existing and new homes is low. We see that gaining slightly during Builder confidence is elevated because completed homes are selling quickly, and in our view, housing starts continue a trajectory aligned to new home sales. Loosening of lending criteria and fewer negative equity loans may provide impetus to two key buyer groups: the first-time, as well as the move-up buyer. Mortgage rates will follow Fed actions. While there may be some near-term disruption, the rate will still be historically low and is not viewed singly as a derailer. At the macro level, U.S. commercial real estate should have continuing occupancy gains and improving rental rates. New construction remains fairly constrained, yet is increasing in some markets, but overall inventory of best properties will remain tight. Opportunities are in the second tier cities. As interest rates begin to rise, investors expect improvements in the economy and in the underlying operating fundamentals, such as leasing and operating efficiency, to support valuations and transactions. Shorter-term leases, such as those found in self-storage and apartments, offer more ability to take advantage of changes in rates and inflation. By contrast, longer-term leases with locked-in rents are most affected by rising operating costs. Global commercial real estate should continue to strengthen, with office transactions and leasing gaining ground. While not uniform nor universal, many cities throughout Europe will experience declining vacancies and increasing rents as economies gain, demand grows and supply remains largely constrained. [ 5 ] Important disclosures provided on page 8.

6 COMMODITIES MARKET VIEWS In 2016, the commodity complex likely tracks sideways after five years of declining. Markets should experience tightening of supply versus demand relationships, with current production reflecting more modest potential demand growth from China. The broad commodity complex is likely to remain responsive to surprise supply cuts and will provide diversification benefits to broad portfolios, especially in regard to geopolitical and natural disaster risks. Energy prices are likely to rise slightly as production slips, which will ease the current supply versus demand gap. Demand growth should remain solid, but inventories will remain an overhang to markets for much of the year. Early in the year, gold may remain under pressures due to U.S. Federal Reserve interest rate increases and our expectations for a strengthening U.S. dollar. Later in the year, the precious metal could find some support from normalizing inflation rates around the world, perhaps finishing the year slightly higher. The pace of decline in industrial metals prices was second only to energy during Investment cuts have been announced and supplies should begin to dwindle. However, the cuts to investment spending in China and our relatively modest global growth expectations implies the supply overhang could remain in place for much of next year due to relatively weak demand growth. Grain markets have seen strong harvests, resulting in strong global supplies in Low prices could lead to more limited plantings, which could lead to some price support, especially if weather patterns turn less favorable after three strong growing years. Commodity prices continued to weaken virtually across the board in This is an extension of the environment we ve seen for the past five years, says Rob Haworth, senior investment strategist, but the decline in the past year was the steepest. He points out that the situation has been unusually challenging for the commodities market. Usually, you can benefit from diversification by owning a broad range of commodities, but over the past five years, there has been little opportunity to escape the broad downturn in prices. Rob expects the situation to slowly improve in Energy and gold markets are reasonably positioned because production has been cut and should begin to more closely match demand levels. The situation is less optimistic for industrial metals. According to Rob, Supplies in industrial metals are robust, and improvement in prices will require more patience. The grain market has seen strong production and lower prices for three years, but he points out that weather events or other uncertainties could create a more favorable environment for grain producers in Robert L. Haworth, CFA Senior Investment Strategist [ 6 ] Important disclosures provided on page 8.

7 POTENTIAL FORECAST SURPRISES FOR 2016 Our investment perspective is based on a careful assessment of the information we have available, incorporating our experienced judgment to forecast the future direction of the economy and markets. We know that various events can occur that will alter the course of the future in a way that is not consistent with our expectations. Outlined here are different scenarios investors should prepare for if our primary forecasts discussed earlier do not come to fruition. Inflation makes a comeback One of the secular trends of recent years has been persistent low inflation across broad swaths of the global economy. At a time when most central banks (with the notable exception of the Federal Reserve) are focused on lowering interest rates or other easing measures, it opens the door to a possible surprise uptick in inflation. If that occurs, bond yields could rise as well (hurting bond values) and equity prices may also be at risk. In the meantime, this might benefit typical inflation-hedging assets, such as real estate, inflation-indexed bonds and commodities. Lagging growth puts pressure on profits Corporate earnings leveled off for U.S. companies in 2015 and recent surveys of global manufacturing have shown cooler activity. If the pace of global growth does not meet expectations or wages rise significantly, corporations may have a difficult time matching profit expectations. Without earnings growth, a consensus may emerge that stock valuations are too high, which could take a toll on stock prices in the short term. Central banks change course If the Federal Reserve delays making significant upward adjustments in short-term interest rates, it could be a sign that the economy remains at risk. That could drive bond yields down, but also may take a toll on stock prices. Likewise, if other central banks around the world that are trying to fuel growth decide to pull back from their easing efforts, investors could be caught off guard and markets may react negatively. The economy surges, boosting real estate values It has been a long climb for real estate prices to recover from the Great Recession. While commercial real estate and housing appear to be back on track, surprising strength in the economy could fuel a boom in values. This could occur if more dramatic wage growth kicks in, giving Americans more confidence as they become increasingly active in the real estate market. An upturn in violent activity boosts oil prices The recent terrorist attacks in Paris and military actions in the Middle East have raised the specter of heightened conflict. That could have an impact on oil production, possibly helping to drive prices higher. Another possible outcome of increasing military conflict is that investors will be looking for safe havens for their money, which could enhance the attractiveness of gold. [ 7 ] Important disclosures provided on page 8.

8 2016 OUTLOOK If you have questions regarding this information or wish to receive definitions of any of the terms used in this commentary, please contact your Wealth Management Advisor or Portfolio Manager. This commentary was prepared in December 2015, and the views are subject to change at any time based on market or other conditions. This information represents the opinion of U.S. Bank Wealth Management and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. Any organizations mentioned in this commentary are not affiliated or associated with U.S. Bank in any way. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes mentioned are unmanaged and are not available for investment. The S&P 500 Index is an unmanaged, capitalization-weighted index of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible difference in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investment in debt securities typically decrease in value when interest rates rise. The risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Investments in high-yield bonds offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer s ability to make principal and interest payments. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes, and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates, and risks related to renting properties (such as rental defaults) U.S. Bank N.A. (12/15) [ 8 ]