Rate rises in the US and the risk of slower global economic growth are likely to prove challenging to share market returns in 2016.
For both economies and markets, 2015 proved to be a mixed year, highlighted by steady US growth, continued improvement in the euro zone following the Greek bailout and concerns over disappointing growth from China and other emerging markets.
Worry about China in particular weighed on most sharemarkets, increasing volatility. By contrast, fixed-income markets held up to expectations of further monetary-policy easing by central banks in Europe and Japan, and delayed rate rises in the US.
How the major economies are looking for 2016
The US economy will continue to lead the way in 2016. But interest rates will gradually rise there in 2016 and bring further volatility across markets in the short term.
Europe should continue its recovery as fresh stimulatory measures by the European Central Bank (ECB) support the region, while the Bank of Japan may extend its own quantitative-easing program to support growth and help lift inflation.
Growth in China should slow from 2015 as the economy continues to transition away from investment towards consumption, though we expect growth should stabilise as 2016 progresses.
The Australian economy is more closely tied to the part of China that is slowing, which means our domestic growth is likely to stay weak as a result. This may see the Reserve Bank of Australia ease rates late in 2016 to support growth. Meanwhile, the forecast El Niño weather pattern is set to weigh on the Australian and New Zealand economies.
With global trade growth remaining soft, emerging markets are likely to bear the brunt of pain from US rate rises as the region has borrowed heavily in recent years to support growth. US dollar debts, in particular, may prove problematic as higher US rates and softening emerging market currencies push up servicing costs.
Which asset classes do we prefer?
Overall valuations continue to favour shares over defensive assets over the coming year, with fixed income looking expensive. However, we see the risks towards slower economic growth, consistent with weak earnings growth.
While the market has somewhat factored in a lower-growth environment, the challenges facing shares may see them underperform in the near term.
Within shares, we continue to prefer international developed markets. Japanese shares are looking positive as the weaker yen has been improving profit margins for many exporters. Europe is another of our favoured sharemarkets as the earnings trend is positive, and there is the potential for further easing by the ECB.
We believe Australian and New Zealand shares will be impacted by weaker earnings due to softer growth, with expensive valuations also weighing on New Zealand returns.
In fixed income, our expectation of gradual rate rises in the US should drive bond yields higher (prices decline), though continued bond purchases in Europe and Japan will limit the rise in yields.
We prefer Australian fixed income as the potential for further rate cuts by the RBA should help Australian bond yields disengage from the expected rise in global yields.
What is the outlook for currencies?
We expect rate rises in the US, combined with continued easy monetary policy in Europe and Japan, to keep the US dollar (USD) strong relative to other major currencies.
Closer to home, the Australian and New Zealand dollars should continue to feel pressure, especially against the USD, as interest-rate differentials narrow and commodity prices remain low.
Overall, we are more cautious of potential downside risks heading into 2016. We will do all we can through actively allocating assets as well as careful fund manager selection to protect capital for our clients through what we expect will be a challenging period.
Or watch Stewart Brentnall, Chief Investment Officer at ANZ Wealth, give a high-level snapshot of what to expect from investment markets in 2016.