What Do The Fundamentals Suggest for 2016?
February 22, 2016
We have a constructive outlook for 2016, based on the fundamentals
2015 is now behind us, an overall lackluster year for Canadian investors. But as I once heard a very good CEO say, the past is only good for one thing: writing history books. What do we expect in 2016?
Obviously 2016 has started out on a sour note, as most stock indices around the world are in negative territory year to date. However, I would remind you that similarly, we saw quite a bit of weakness in early January 2015. Despite being down during the first few trading days of the year, the S&P500 finished 2015 up 1.4%, the EuroStoxx 600 Index finished up 10.3%, and the Topix Index in Japan finished up 12.1% for the year. Even the Shanghai Index, the cause of so much market angst since August, finished the year up 11.2% (although well down from its mid-year highs). The S&P/TSX was down for the year, but that was due in large part to its heavy commodity exposure, and weaker than expected performance by the banks.
While no one can predict the future, when assessing the longer term health of the markets and how to be positioned, it is always best to focus on the fundamentals. What are the fundamentals telling us today? Let's look at GDP growth, valuations, earnings growth, and yields.
Global GDP Growth
According to Citi Research, Global GDP Growth in 2016 is expected to accelerate versus 2015. Estimates call for 2.7% growth in 2016, compared with 2.6% in 2015, and preliminary estimates call for further acceleration in 2017. While the growth in the rest of the world is improving, Chinese GDP growth estimates call for the slowdown to continue (6.9% GDP growth in 2015, 6.3% in 2016, and 6.2% in 2017). While a continued slowdown may not be great news for base metals prices, it is important to recognize that according to current estimates, a slowdown in China is not likely to cause a recession in developed markets.
How expensive are equities today? When looking at a 45 year history of the MSCI World Index, you will find that the current trailing P/E is at its median level. Tough to argue for significant multiple expansion from here, but also tough to argue for significant valuation compression as well, given where we are in the current equity, economic, and interest rate cycle.
Again, according to Citi Research, on a global basis, earnings are expected to grow between 7% to 8% in 2016. In fact, Citi's estimate for earnings growth in Canada is right in line with the rest of the world at 7.2%.
The vast majority of developed markets today have a local dividend yield which is higher than the local 10 year government bond yield. This is driving assets out of government bonds and into investments like equities and high yield bonds. In the high yield fixed income market, yields are very attractive, and despite market weakness at the end of 2015, these higher yields should translate into better returns for the remainder of 2016.
Outlook For 2016
Are there risks to the outlook? Of course. There are always risks. The global economy could slow, the U.S. Federal Reserve may raise rates at a slower pace than expected, oil prices could weaken further (our energy team thinks current oil prices are unsustainably low), etc. It is important to remember though that tough markets always highlight the risks, while good markets ignore them. The truth is almost always somewhere in between.
So what do the fundamentals suggest? In summary, the global economy continues to expand, valuations are reasonable versus historical levels, earnings forecasts suggest appealing growth rates, and both equity and high yield bond yields are attractive. The current investment climate is difficult, and investors are naturally anxious. When looking at the fundamentals however, we continue to have a constructive outlook for the balance of 2016.
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