Here’s What’s Likely to Unfold During 2016 (3K Views)

This year, more so than most, the “consensus” outlook for 2016 is universally, and to some degree exuberantly, bullish suggesting that:

• 2016 will be a continuation of the last seven years with respect to rising stock markets with estimates the S&P 500 could top 2300 next year and, hopefully, that
  
• the economy will return to stronger trends of economic growth to finally achieve “escape velocity” which will lead to real improvements in employment and income growth.

By Lance Roberts (realinvestmentadvice.com)

Could such really be the case? Honestly, I don’t know, however, the following are my best “guesses” for the coming year, based on the statistical and technical data trends, for the market, interest rates, the dollar, employment and the economy.

A Recession Is Coming

With the Federal Reserve now intent on tightening monetary policy in a weak economic growth environment, the odds of a negative return year in 2016 has risen markedly. However, while 2016 is likely to be a negative return year, it is either late 2016 or early 2017 that the economy slips into a recession and the next major market correction occurs. While that is what the historical statistics suggest, it should be noted that previous market cycles were not operating at the lowest average annual rates of economic growth on record. There are many issues that could advance the recessionary cycle/market reversion into 2016.

Global Stock Markets Will Decline

It will most likely not be just the S&P 500 that declines in 2016, but industrialized international markets as well.  In fact, if history is a guide, the decline in the international markets is already providing a leading indication of a negative return year for the S&P 500. Despite hopes of a stronger economic environment, ongoing liquidity from global Central Banks and negative rates, the reality is that those supports have already been “weighed, measured, and found wanting.”

Interest Rates Will Decline

With the Federal Reserve raising interest rates on the short-end (Fed Funds), it will likely push the long-end of the curve lower as the economy begins to slow from the effects of monetary policy tightening.

From a purely technical perspective, rates have been in a long-term process of a tightening wedge. A breakout to the upside would suggest 10-year treasury rates would soar to 3.6% or higher, the consequence of which would be an almost immediate push of an economy growing at 2% into recession. The most likely path, given the current economic and monetary policy backdrop, will be a decline in rates toward the previous lows of 1.6-1.8%. (Inflation will also remain well below the Fed’s 2% target rate for the same reasons.)

If the Fed does indeed follow their determined path to raise the Fed Funds rate by an additional 1% in the coming year, the result will be a nearly flat yield curve which will remove another “leg of support” from the bulls.

Of course, falling rates means the ongoing “bond bull market” will remain intact for another year. In fact, if my outlook is correct, cash and fixed income (non-high yield) will likely be one of the best performing asset classes in the next year.

Oil/Energy Will Remain Weak

Unfortunately, while energy has already been in a bear market over the last year, it will not improve much in the coming year. Around mid-year, the majority of oil price hedges will have expired and the impact of collapsing oil prices will be reflected in two major areas – energy sector profits and energy related debt.

Over the next year, energy prices will likely remain under pressure as the supply of oil continues to outstrip demand. The last time that oil supply was at current levels, oil prices remained mired in a trading range for twenty years. With global growth weak, inflationary pressures low and debt levels at historically high levels, it is unlikely that the resolution of the supply-demand imbalance will be resolved in just a couple of years.

As hedges expire, profits will continue to erode, production will be shut-in, unemployment will rise, CapEx will be cut further and debt-defaults will rise sharply. All of these issues will have broad-reaching economic impacts which will be reflected in weaker rates of economic growth.

The U.S. Dollar Will Weaken

One of the most “crowded trades” in the market today is the long-dollar trade. Historically speaking, and from a contrarian viewpoint, any time that a trade has become “crowded” it has been near its end. The strong dollar, which has been the result of a global race to the bottom for other currencies, has negatively impacted economic growth in the U.S. as exports have declined…As economic weakness accelerates over the next 12-18 months, due to tighter monetary policies, the dollar will weaken.

Employment Rate Will Decline

As with all things, what goes up will eventually come down. Employment is no exception. While the Federal Reserve has pinned their hopes on persistent employment growth into the infinite future, the reality is the current economic and employment cycle are nearing completion...In the past where the Fed has begun hiking interest rates, the first rate hike has marked the peak in the employment cycle in all cases.

As the economy weakens in the coming year due to the continued pressure from the deterioration in the energy sector, weak wage growth and deflationary pressures from abroad; the employment situation will begin to worsen.

Conclusion

The common theme throughout the outlook for 2016 is continued weakness in economic growth. The current economic expansion is one of the longest on record, but has also been at the lowest average rate of growth of any cycle on record. This leaves very little room for any type of policy error.

Statistically speaking, the odds suggest that cash and fixed income are likely to provide some of the highest rates of return in the next year barring a complete reversal in monetary policy by the Federal Reserve.

This is not a “bearish forecast.” It is just an assessment of trends, statistics, and probabilities given the current monetary, financial and economic backdrop. (Go HERE for my recommended asset allocation model currently as we head into 2016.)

If I am wrong, and stocks do post modest gains in the coming year, being more conservative will only mean a small relative under performance in your portfolio next year.

If I am right, the preservation of capital will be far more beneficial. As I have stated previously, participating in the bull market over the last seven years is only one-half of the job. The other half is keeping those gains during the second half of the full market cycle.

I do not have an enviable job. I am not a fortune teller, or a psychic, but investors always want to believe that I know something that they don’t. This is simply not true. All I can do is analyze as many of the facts as possible so that you can make your own financial decisions as we head into the coming year. However, I can tell you this – Wall Street is a massive organization whose business is to sell you product and telling you to get out of the markets is not profitable for them. Therefore, when listening to mainstream analysts and economists make sure and weigh their comments with respect to their financial benefit.

As we enter into 2016 it may pay to be a little more cautious after such a large rise in the financial markets. Think about it this way – if you need to grow your assets by 5% per year from now until retirement, the last 6-years have advanced you more than 20-years towards your goal.

Raising cash and protecting that cushion really shouldn’t be a tough decision. However, not doing it should make you question your own discipline and whether “greed” is overriding your investment logic.

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