“The only function of economic forecasting is to make astrology look respectable,” John Kenneth Galbraith, an irreverent economist, once said. Yet each January strategists fill the airwaves, prognosticating what the coming year may bring. Amongst the most eagerly anticipated is Blackstone’s Byron Wien’s annual “Ten Surprises.” In this vein, Bob Reiser, Senior Advisor to the Investment Strategy Team, publishes his annual forecast. As always, the views expressed herein are solely those of Bob Reiser’s and may not be shared by other members of the Investment Strategy Team, but they do highlight where the prevailing consensus today may be most complacent.
Last year was one of high tragedy in the Middle East and Africa and low humor from the presidential candidates in the U.S. With a stock market that only eked out a small gain, I am happy to put the year behind us.
How did my 2015 forecasts do?
On balance, my January 2015 forecasts were in line with results and would likely have kept investors out of trouble. A summary of last year’s forecasts are shown in bold:
- Stocks, in general, still look to be better value than bonds Long-term Treasury bonds fell while the S&P 500 ended slightly ahead of where it started the year, including dividends, but well below what I expected. Nevertheless, last year marked the seventh year of a bull market, which makes it the third longest bull market on record. The bottom was March 2009 with the S&P 500 at 666. Today the S&P 500 is near 2000 – almost 300% higher.
- The U.S. economy may not be as robust as many pundits think. The U.S. economy continued to grow but at a decelerating rate. Third quarter real GDP growth was 2.0% or about one-half the second quarter rate.
- There is reason to believe that growth in the U.S. will continue for several more years, supported by low energy costs, an adequate work force, and plenty of capital. The unemployment rate fell to 5%, the lowest rate since 2008, and monthly job growth accelerated to almost 300,000.
- Slower growth puts pressure on corporate profits and with elevated market valuations I believe that a market correction is highly likely this year. There was a market correction of more than 10% in the summer.
- There will be opportunities in select foreign markets. An investment theme for this year needs to be selectivity: maybe not the world but perhaps Japan; maybe not Europe but perhaps the U.K. and maybe not all emerging markets but perhaps India. Select foreign countries looked attractive, mainly due to real efforts at structural reform. Our Investment Strategy Team wrote extensively about Japan, for example, throughout 2015.
- Interest rates cannot go down much further with the 10-year Treasury bond yielding 2%. With an improving U.S. economy, we assume that short-term rates will start to rise. While short-term interest rates moved very little in the year, the Federal Reserve began to increase short-term rates in December.
Is 2016 really that predictable?
To paraphrase Donald Rumsfeld, if you don’t know what you don’t know, forecasting is a crapshoot. It is important to understand the level of certainty displayed by investors; the more uncertainty, the harder it is to be right in a forecast, but when there is a high degree of consensus, forecasting is easier when you consider that consensus is frequently wrong.
Starting with these two principles, what can we divine about the markets in 2016? Uncertainty is highest in the social-political realm. Will a Republican or a Democrat be elected President? Will Congress eviscerate the Affordable Care Act, restrict immigration, or cut taxes? We do not know how Europe will handle the refugee crisis – another one million people could seek asylum in 2016. We don’t know what Russia, Syria, Turkey, or China will do. In other words, we have to ignore these issues when making a market forecast. Unknowables are really “black swans” – events that are unpredictable but highly consequential.
There is, however, a high degree of consensus from Wall Street for the 2016 outlook. As reported by MarketWatch, the general consensus of 10 large Wall Street firms is as follows:
- Another modest year in the stock market with a target for the S&P 500 of 2100-2300 (currently below 2000);
- Consumer-led growth in the United States;
- Slow global growth;
- Stable oil prices;
- Lower commodity prices;
- Continued strong dollar;
- Rising short-term interest rates.
This is a comfortable forecast in which Wall Street does not scare anyone, hugging the trunk of the tree rather than going out on a limb. But is 2016 really that predictable?
Let’s start with the fact that it is the fourth year of a presidential cycle. This does not mean much for the market; fourth year returns tend to be below long-term market returns but not by a large amount. However, a study done by Brian Belski, Chief Investment Strategist of BMO Capital Markets, found that since 1928, in the year a “new” President is elected, the market declined 4%. So the presidential cycle must be viewed as a negative.
Other technical factors are also looking negative. For example, how the market does in the first five days of the year (down 6% during the first week of 2016) signals the rest of the year. We will have to wait to see January’s market performance for a clearer signal. Another signal of some dubious note is the winner of the Super Bowl (stocks are supposed to rise when the winner comes from the old National Football League).
If 2016 is an up year in the stock market, it will be an eight-year bull market, exceeded only by the market rise starting in 1990, which lasted 9.5 years.
The more interesting questions are where the consensus may be wrong. Here are some of my concerns:
- Corporate profits could decline because of a slow economy, low revenue growth, squeezed margins from labor pressures, and a strong dollar.
- The Federal Reserve, faced with modest U.S. growth, could defer its march to higher interest rates.
- The European refugee crises could have a more negative impact on European economies than first expected. (See Balentine’s 2016 Balentine Capital Markets Forecast: Creative Solutions in A Returns Challenged World for more on this topic).
- Global growth may stagnate, with only a few countries standing out.
- There may be an implosion in the Middle East. The most recent developments between Saudi Arabia and Iran appear to raise this risk.
In summary, I believe that we can expect negative returns for the stock market in 2016. I expect a rebound this spring if Emerging Market currencies, particularly China’s, stabilize, but perhaps increased market volatility around the fall elections.
For the final surprise, I expect Hillary Clinton to be elected President. If Mrs. Clinton is elected, the odds are that it will also be negative for the stock market, given the continued split between Congress and the President.