Our Predictions: Outlook on Four Markets in 2016

As we close the books on 2015, I can’t help but think about how wrong I was about how it would all play out. I wish I had not been so bold about some things, and been bolder about other things. I really thought that, by now, we would all be looking at the Fed implementing QE4. But longtime readers know all too well that I am usually months ahead with my calls on things before they come to fruition. So, keeping all that in mind, I thought it would be a great idea to go to each “guru” in the Global Markets division, and get their take on how they see 2016 playing out. So we have our metals guru, Tim Smith; our stocks guru, Joseph Stolzer; our bonds guru, Chris Gaffney; and of course, your currencies guy, me. We’ll all try to look into a crystal ball and tell you what we see for 2016. So this should be good—let’s go.

The Outlook on Equities
First up, what everyone is really concerned about: stocks. Here’s Joseph Stolzer, from our Wealth Management division.1 Joseph is a Chartered Financial Analyst (CFA), which gives him a unique look at all markets. In fact, Joseph, Chris and I sit on the Investment Committee for the Managed Currency accounts. We’ve asked him to give us his view on stocks for next year—not individual stocks, but the stock market as a whole. Here’s Joseph:

Picture a lake on a calm day—the water is still without any disruption. Throwing a rock into the water will create several ripples that will spread across the body of water. Eventually the water will become still again, but it will take some time. The volatility in the Chinese equity markets and one-time devaluation of the yuan, the rout in oil prices, and the first Fed funds rate increase were all rocks thrown in 2015 spreading volatility into equity markets. Has enough time passed so that the market has become still again? No. While the overseas concerns from China have seemed to calm, the rout in oil prices continues to drive the markets and will likely persist into 2016. How soon these ripples fade will be just as important as anticipating the next rock to drop as we look at what to expect for equities in 2016.

It is important to remember that the equity market is never completely still, and even with the volatility that we have seen, the general environment does remain supportive for equities overall. The slow growth in the U.S. combined with low inflation provides a strong backdrop for domestic equities while the commitment to ease from the European Central Bank creates a backdrop for European equities reminiscent of the U.S. a few years ago. Increases in the Fed funds rate will create higher borrowing costs for companies and could continue to add headwinds in the form of the stronger dollar. Equity markets, however, should easily absorb the slow projected path of interest rate hikes, while we are likely to have seen the majority of the dollar strength, and currency headwinds should be expected to fade from year-over-year earnings comparisons.

Focusing specifically on domestic equities, several areas of the market will be interesting to watch. While lower oil prices have translated to lower gas prices helping our wallets, it has also caused the energy sector to be the worst performing sector of 2015. From a long-term perspective and compared to historical valuations, the energy sector looks to be undervalued. For those who can stand the volatility and have a bullish view on energy prices, this sector offers some companies that have solid fundamentals but have sold off with the broad energy sector. Financial companies were some of the hardest hit in the 2008 financial recession and haven’t recovered as much as other sectors since then. The normalization of interest rates could provide catalysts for this sector’s outperformance. Finally, it will be interesting to continue to watch the technology sector, which was the top performer in 2015. Innovation from technology companies continue to disrupt old systems, and it will be interesting to watch if these companies will be able to profit from new ideas.

The Bonds Market
Next is Chris Gaffney, President of EverBank World Markets (my old gig), and a CFA to boot. Chris has had an exciting year, taking over the reins of World Markets from me, finishing his first IronMan competition, and lots of points in between. Being a CFA gives Chris the ability to seek out the good and bad in all markets, so I’m sure he was upset when I said I would do currencies, but that gave him the opportunity to display his multi-talents and talk bonds. Here’s Chris:

Global fixed income markets were surprisingly resilient in 2015–mostly due to the continued bond buying that the major central banks undertook in their efforts to stimulate their economies. With the U.S. Federal Open Market Committee (FOMC) expected to begin raising rates in 2016, one might expect the fixed income markets to suffer as potentially higher rates bring the price of bonds down. But the U.S. Central Bank is going it alone with their interest rate increases while the Bank of Japan, European Central Bank, and even the People’s Bank of China have all indicated they would continue to have their foot firmly placed on the stimulus pedal, which means more bond-buying in 2016.

And even here in the U.S., the yield curve does not agree with the notion that interest rates will begin a sharper path higher in 2016. While the FOMC can have a direct impact on the shorter area of the yield curve (by raising the Fed Funds or discount rate), rates at the longer end of the curve are determined by inflation/growth expectations. The recent FOMC move has only led to a flattening of the curve, and this pattern will likely be repeated with future interest rate increases in 2016 unless (and this is the big question) signs of higher inflation or stronger growth begin to filter into the markets.

The European debt crisis is largely in the rear view mirror as we cross over into the New Year, and the real focus of debt investors has shifted to the distressed or high-yield debt issues. The junk (a more common and perhaps appropriate description) bond market saw its worst selloff in more than four years during 2015, and the selling could continue into the New Year. While most of the focus is on the energy sector, which used these high-yielding bonds to finance energy-related projects in what was once the most rapidly expanding sector of the U.S. economy, oil-related companies make up less than 1/5th of the junk bond market in the U.S. Falling oil prices will definitely continue to weigh on the junk bond market, but rising yields are a much larger concern. High-yield companies’ balance sheets are not healthy (part of the reason why they have to issue high-yield bonds) and since most of this debt is shorter duration, any increase in short-term rates could lead to more defaults. Investors expecting a slower U.S. recovery and higher rates will continue to demand higher premiums from these distressed companies.

So where does that leave global fixed-income investors? One place that those investors may want to look is with shorter term durations (3 years and in), particularly those that are direct sovereign debt or AAA-rated ‘supranational’ issues. Investors may be surprised to learn there are shorter-term duration supranational bonds currently with yields ranging from around 3% to up over 12% for investors interested in VERY speculative issues.

2016 Precious Metals Outlook
And now, without further ado, is our metals guru, Tim Smith. Tim has recently announced his engagement to a wonderful, lovely young lady, named Nicole, and so the circle of life does continue on. Here’s Tim:

Precious metals, and commodities in general, just suffered through a year that saw heavy losses and multi-year lows. After the bloodbath that was 2015, it is easy to see why investors may not be as bullish on precious metals as they once were. Gold and silver have fallen dramatically from their peaks in 2011, and oil has recently hit an 11-year low. The Fed just raised rates for the first time in almost a decade, and stocks are maintaining their lofty price levels. In spite of all of this, I don’t believe we will see a repeat performance for metals in the coming year.

While conventional wisdom says that higher interest rates are bad for precious metals, which do not generate interest income, this may not be the case going forward. The Fed obviously thinks the economy is doing well enough to continue to move rates higher, and that means inflation may be coming back, which is typically good for precious metal prices. And while the strong dollar may continue on into next year, demand from outside the U.S. has continued to be strong, especially in China, Russia and India, and does not look to be slowing down anytime soon. This strong demand for physical metals has also led to supply shortages recently, and should the shortages become more extreme, basic supply and demand laws would dictate higher prices. Also, if the unintended consequences of zero interest-rate policy (ZIRP) and quantitative easing (QE) finally catch up to the U.S. dollar and send it down in value, we could easily be in store for a spike in commodity prices. Of course there may be unseen forces at play here, but overall the current price levels look mighty attractive for someone looking to diversify their portfolio with some hard assets.

Generally speaking, I believe we will see higher prices at the end of 2016 compared with the beginning of the year, but I’m not sure we will be completely out of the woods by that time, and the gains will most likely be modest overall. Of course we could still see a major recovery should some unforeseen circumstances arise, but all things being equal, I think we are at a point where the upside potential for precious metals well outweighs the downside risk.

My Outlook on Currencies
And finally, I’ll talk about currencies. It’s been a long five years of dollar strength hasn’t it? The first couple of years—2011 and 2012—really didn’t shout “strong dollar trend,” but if we were looking closely we would have seen the signs, especially in the emerging markets and vs. the euro. The thing that kept me off the scent of a strong dollar trend in those early years was the sterling performances of the Aussie and New Zealand dollars. In 2013, I still didn’t believe we were in the midst of a multi-year strong dollar trend when I got the audience in Vancouver to sing along with me after describing the calls for the dollar to be in a sweet spot, which reminds me of the Trini Lopez song, ‘Lemon Tree.’ The debts of the country continued to grow, and it was beyond my ability to see that the markets had grown ‘Comfortably Numb’ with the size of the U.S. debts, for if they realized the problems that a debt of that size would create, they would not be buying dollars.

So that’s been my life the last couple of years, living with the black mark on my career that I didn’t see the dollar trend until July 2014. To rectify this, I have some thoughts on just how long this strong dollar trend will last. First of all, the completed weak dollar trend that began in 2002, and ended in 2011, was quite long given that most currency trends last between five and seven years. Will this strong dollar trend last as long? I don’t believe so, and quite frankly I think the only thing keeping the strong dollar trend on life support now is the Fed rate hike—and calls for more rate hikes in 2016. And that’s where I think we’ll have the cheese that binds. If the Fed goes ahead and continues to hike rates, most likely in March and June, I do believe those will be the last of the rate hikes. And the Fed’s next move after June will be to cut rates again, and eventually return to bond buying with QE4.

So keep the hatches battened down, and look for brighter times for the currencies by summer. The dollar should be in shambles by fall, and who knows where we go from there. I continue to like the currencies from countries that have something real to export that other countries need and want. And I really like the prospects for gold in 2016 and beyond, but that’s Tim’s bailiwick so I’ll leave the talk on gold to him.

So there’s your 2016 outlook from the gurus at EverBank Global Markets. I hope this helps you as we go along in 2016, and of course I sure hope we all end up being right. But even if we’re not, these were our opinions and views, and they were all based on our educations, knowledge in the markets, and, of course, our experience. It doesn’t get any better than that.

Until the next Daily Pfennig® edition…

Chuck Butler
Managing Director
EverBank Global Markets Group