Cycles Out of Sync

The monetary policy cycle has dominated financial markets for years. As the global liquidity wave crests, the business, credit and valuation cycles should gain in importance. Unusually, these cycles appear to be out of sync. This argues for careful navigating in 2016.

• We see an extension of the business cycle as crucial for further gains in risk assets. With valuations no longer cheap and corporate profit margins under pressure in many markets, economic growth is needed to boost revenues.

• We expect little or no price appreciation in fixed income and only muted gains for most equity markets in 2016.

• China’s economic deceleration and shift to a consumer-driven economy are putting the brakes on the global business cycle. Both are part of a natural evolution but pose structural challenges to emerging markets (EMs) and commodity producers. We expect China to muddle through. Risks, including a yuan devaluation, are rising – but we do not see them coming to a head in 2016.

• The knock-on effects of movements in oil prices and the US dollar are critical. Falling oil prices have dragged down long-term inflation expectations. This is puzzling and brings into question the credibility of central bank inflation targets. The dollar’s rise has led to some tightening in financial conditions. Further gains would intensify pressure on US profits, commodity prices and EM currencies.

• EM economies are in a downturn due to their China dependency and the commodity price implosion. Cyclical factors such as an uptick in global growth and better trade balances due to currency depreciations could give a (temporary) lift to depressed EM equities.

• The US economic expansion is following the script of a grinding advance after a banking crisis and likely has room to run. A lot is riding on the recovery as other economies are struggling. We see a gradual path to higher US rates in 2016, but think the market has priced in too few rate increases given jobs, wage and inflation trends. We see rising US rates widening monetary policy divergences.

• The eurozone is in (weak) recovery mode, helped by bank credit growth and a falling euro. The monetary policy cycle has moved into high gear with a negative deposit rate and quantitative easing (QE) until March 2017. We see this supporting eurozone equities and corporate bonds. Risks include threats to European unity such as the refugee crisis and the possibility of a ‘Brexit.’

• Long-term trends such as ageing populations, high debt loads and technological change are intersecting with short-term cycles. This means the high growth rates of the past may not return. The good news? We see a modest pick-up in global growth, and a renewed investor focus on fundamentals.

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