Investment Outlook 2016: Subdued Growth, Low Inflation, Modest Returns
Growth in most developed economies is likely to remain on current level. In many emerging countries, the rebalancing process may continue to depress growth. As a result we expect that inflation will generally remain low. We anticipate credit and equities to deliver better returns than core government bonds, and believe the US dollar will make further gains.
At the beginning of 2015, our forecast for real global growth stood at close to 3.5 percent, but we gradually had to lower this to below 3 percent. Factors affecting growth include long-term forces such as demographics and the short- to medium-term impact of tighter policies and deleveraging in emerging markets in response to previous credit excesses.
Slower growth has continued to exert downward pressure on commodity prices, with additional disruptive effects for some countries that rely on raw material exports. In our 2016 forecast, we have tried to take account of the slower long-term growth trend, while assessing the extent of repercussions of the shorter-term forces.
Global Growth Too Weak to Raise Inflation
The global economy will most likely remain on a moderate growth path in 2016, unless some major geopolitical shocks or significant policy errors occur. However, growth will remain too weak, in our view, to trigger any significant rise in inflation and we expect prices of traded manufactures to keep falling. That said, commodity prices should gradually be supported by cutbacks in investment and production, so that headline inflation should rise somewhat in the course of 2016. In the USA and UK, where the recovery has been underway for some time, domestic core inflation should also rise gradually toward the central banks' 2 percent target as unemployment falls and service providers regain some pricing power. But inflation is set to stay below target in Japan, the Eurozone and Switzerland. Inflation is also likely to remain low in China as well as emerging markets in APAC and Eastern Europe. Finally, countries which have suffered bouts of inflation in the past two years as a result of either sharply depreciating currencies or high government spending should see inflation abate as currencies stabilize.
We Favor Global Equities
From an asset allocation perspective, we see the greatest potential in favoring global equities relative to global bonds. Within equities, we favor exposures where the source of liquidity is likely to be most consistent, most notably the Eurozone, and where the sector uptrends appear to have the most structural support, i.e. healthcare and technology. Among credits, the widening of spreads in 2015 has created significant risk premia that appear to overestimate aggregate corporate default risks in 2016 and thus offer potentially attractive expected returns – but selectivity at a regional, sectoral and issuer level is key, as the default cycle is turning and continued Fed tightening would amplify corporate event risk in coming years. Investors should maintain a high degree of diversification, focus increasingly on selectivity of sources of yield, and pursue a tactical bias for deployment of capital. Pockets of volatility may emanate from the Federal Reserve's tightening, economic shocks, illiquidity or geopolitics, but an underlying picture of ongoing growth is expected to see investor patience rewarded.