Though it's difficult to pinpoint what specifically might have been the biggest market story of 2015, it's clear that the collapse of the commodity sector—oil's 35% decline in particular—was at the forefront of everyone's list of concerns. The strong US dollar was another culprit. Though it benefited some retailers, it wreaked havoc on many emerging market economies including Russia, Turkey, Brazil and South Africa.
The timing of the Fed's rate decision was another big story that occupied traders and investors until year-end when Ms. Yellen finally delivered and markets—at least in the short term—jumped on the news.
Then of course there's China: Its economy, most analysts agree, is slowing and undergoing a major shift away from manufacturing, toward services. The country's Shanghai Index had a roller coaster year, skyrocketing up into the summer months, then rapidly down as the fall months began. The PBoC had been devaluing the yuan in small increments throughout 2015 in an effort to groom the currency for inclusion in the IMF's SDR basket of key currencies, but on August 12 it blindsided FX markets when it engineered a 2% drop "to make its exports more competitive and shore up growth in the flagging economy."
With such a full year in the markets' rear-view mirror, and as 2015 winds down, we asked 11 of our most popular contributors how they're preparing for the coming year. We received a provocative mix of views and strategies and have divided the responses into two articles. Part I, below, covers commodities, currencies and contrarian opinions. Part II, which we'll publish later this week, offers insight into where the US's 7-year equity bull might be headed.
Stocks probably need to consolidate for the first half of next year before they can break out to new highs and start the run into a bubble phase top. The correction into the S&P 500's 7-year cycle low in August wasn’t deep enough to properly correct the excesses of 6 years of QE, so I expect that will delay the beginning of the bubble phase for a while as the 200 week moving average will need to “catch up” to price during the beginning of the year. I’m expecting a rather volatile market with several mini-crashes as the market continues to try to correct and the Federal reserve and other global central banks try to prop up markets with their printing presses.
Commodities have been severely underperforming for three years. It’s time for them to form a final bear market bottom and outperform next year. The bottom may have occurred in November, or if oil can make one more lower low it could stretch out to the spring of next year, but I do think 2016 will be the year for commodities to shine.
Again this year everyone expects the dollar to soar. It’s still too stretched above the long term mean to expect a move to 110 or 120 this year or next. So I suspect the currencies will remain stuck in a sideways consolidation for most of 2016.
Picking winners 12 months out is extremely difficult, but there are some trends and themes that are certainly worth paying attention to. The euro vs the US dollar is one pair that I will be looking at as I believe we will see it reverse much of the slide we saw in 2015. The Fed have talked the market into believing interest rate liftoff is upon us, but I believe this only opens the door for disappointment. The Fed have said rates will rise slower than expected and I do not doubt them on that. The US dollar will likely weaken as the glacial pace of interest rate rises will not live up to the market’s expectations, and any rate rise may affect adversely US growth.
That brings us to the euro. As we have seen, the ECB are still willing to expand stimulus, but the need will diminish. 2015 has ended rather positively for EU businesses, with growth, spending and even hints of inflation returning. I believe this trend will continue into 2016 which will be seen in the ECB’s monetary policy actions. The dovish rhetoric will slowly turn to neutral and the market will realize the euro has been oversold. I would not be surprised to see the euro return above the 1.20 level on EU strength and USD weakness.
Silver is also going to be on my watchlist for 2016. The metal has been hammered lower in 2015 thanks to the expectation that US rates will begin to rise. The metal will likely find buyers below the $14 mark with $13 looking like a line in the sand. If rates rise more slowly than expected, or growth begins to tail off in the US, look for the silver bulls to have a field day.
Entering into 2016, the major talk of the town is the Federal Reserve's desire to raise interest rates for the first time since 2006. Financial experts are very much divided as to whether or not this will end up being a good idea. Observing the United States equity markets, where the S&P 500 is trading only a couple of percentage points from its all time high, one could easily conclude that all is well. However, those with a sharp eye should easily notice that the state of the financial markets is quite fragile right now.
For example, consider the weakness in MSCI Europe and MSCI Emerging Markets stocks, both of which peaked in the middle of 2014 and remain in a downtrend. The junk bond market has been under pressure too, trading at the lowest level since October 2011. Finally, there is carnage in the commodity market (especially in Crude Oil), which is clearly affecting mining and energy producers.
Therefore, the risks in predicting which asset classes will outperform in 2016 is connected to the divergence in monetary policy around the world. As the Federal Reserve embarks on its tightening cycle, while other central banks (such as the ECB and BoJ) continue to ease, we are expecting volatility to be high throughout the year. Let us consider our main recommendation for 2015, which was favouring Chinese equities (iShares China Large-Cap (N:FXI)) over their US counterparts. This trade worked very well for the first half of the year, with H1 total return gains exceeding 25%. However, very quickly, panic gripped global equity markets and by the fall of 2015, we saw the VIX above 50 and a mini stock market crash around the world. With this in mind, timing markets throughout 2016 could play a critical role for those investors who wish to achieve above average returns.
As long as nothing dramatic happens in the coming months, the US equity bull market will have its 7th year anniversary in March of 2016. Investors should note that valuations are getting very stretched (price-to-book is at 3 times) and revenues / earnings have disappointed as of late. Nevertheless, the primary trend remains up and the tape is signalling higher prices ahead. We expect the S&P 500 (SPDR S&P 500 (N:SPY)) to break out towards new highs within the first quarter or two of the year. Having said that, the rise in the index has been accompanied by ever narrowing breadth and somewhere down the line the market could eventually run out of steam.
On the other hand, Chinese equities (FXI) are trading at relatively low valuations (price is below book value) and have the potential for recovery after being down again this year. Macau gaming stocks such as SJM Holdings (OTC:SJMHF), Sands China (OTC:SCHYY), Wynn Macau (OTC:WYNMY) and so forth are a contrarian's delight, particularly for those with higher risk appetite.
Speaking of contrary plays, we also favour the S&P energy sector (Energy Select Sector SPDR (N:XLE)) and energy producers like MSCI Russia (Market Vectors Russia (N:RSX)) in 2016. However we wouldn’t buy either of these indices until WTI Crude Oil tests the critical support level around $33 per barrel from early 2009 and first shows clear signs of stabilising. Finally, the greenback still continues to be our main currency of choice, and while volatility will remain high (think of the recent December ECB meeting), we expect the US Dollar Index to be trading at new bull market highs sometime in the next year.
In looking forward to 2016 it is perhaps worthwhile briefly to reiterate the dominant themes of 2015, not least of which has been the attempts by the Fed to normalize monetary policy, the continued and relentless decline for commodities, in part due to the strength in the USD, and finally the sustained rally for equities which continues to defy many market experts.
Indeed if any of these trends is to reverse dramatically in 2016 the principle influence is likely to be inflation, or the lack of inflation, and it is this factor which in my opinion will affect much of the tone for the year ahead.
Whilst the Fed may hope to see a return of inflation, albeit in a modest way, the economic data thus far tells a different story, and much of the rhetoric that has been forthcoming would appear to be based on hope rather than anything more concrete. One could also argue that in taking a decision to increase rates, this in itself has been designed to inject some much-needed confidence into the market, and in particular the retail sector, whilst simultaneously saving face. Given the recent statements in Europe, and with the suggestion of a major slowdown in China, the economic outlook globally remains extremely fragile, and it would be no surprise next year to see the Fed fail to increase rates again, and indeed one could argue that they may even consider a cut, although this would be unthinkable for the preservation of their reputation.
The single biggest factor currently contributing to this low inflation environment is, of course, oil. In 2014 I anticipated that oil prices would likely be in the $40 per barrel region by the end of 2015, but even I have been astonished by the relentless decline in prices which has resulted in prices moving down to a low of $35 per barrel. There are many and varied factors for this, not least Saudi Arabia's decision to take on the alternative producers in a price war, and with Iranian sanctions set to be lifted in January, which will result in a further 1m barrels a day flooding the market, oil will most definitely continue to take center stage in 2016.
From a technical perspective there is little to suggest that we are at a bottom for oil prices, and indeed on the slower time frames of the weekly and monthly charts there is a distinct lack of buying and the prospect of a buying climax some way off. My view is that there is further downside to come, and we are likely to see WTI oil prices shed a further $10 a barrel, before any major buying comes to the market.
Furthermore, whilst one of the direct impacts for oil prices is, of course, in terms of inflation, one of the less obvious is in those indices heavily dominated by oil company stocks, and here the UK's FTSE 100 is a classic example. Over the last few months we have seen a major divergence between the bullish momentum of US indices, and bearish sentiment in the FTSE100 as the price of oil drags these stocks lower.
Staying with the commodities theme, the outlook for gold remains equally bearish in the early part of the year. However, I am expecting a bottom to be reached once the metal moves below $1000 per ounce, and it may even reach $900 per ounce next year. As always any buying climax will be signalled by volume on the slower time frame charts.
Silver too is likely to follow gold lower, with a possible bottom forming in the $10-$11 per ounce region.
To round off on commodities, the decline in copper has been dramatic, and indeed counter-cyclical to its conventional role as representative of economic health. In other words the term Dr. Copper could not be further from the truth, and given the bearish technical picture I am expecting the metal to continue selling off with a possible move to 1.400, last seen in March 2010.
The economy everyone will be watching next year is China where the hope is for a gradual decline in economic growth, and a soft landing. However, given the track record of central bank management of economic and monetary policy, a hard landing would be no great surprise, and should this occur the effects would be dramatic and impact commodities, commodity currencies and equities in equal measure, and make the financial crisis of 2008 appear as no more than a minor correction.
Moving to currencies where 2015 provided a high degree of volatility and some great trading opportunities, 2016 is likely to continue in this vein, and for the majors much will depend on whether the USD index continues higher, and can overcome the resistance now firmly in place in the 100.20 region. Should this be breached, as seems likely, then the index may continue its bullish tone for much of next year, and we could see a test of the 104 region, last seen in 1999. The congestion phase that has been building on the monthly chart since February 2015 certainly suggests further upside momentum to come.
For the euro, the only question for 2016 is whether parity will be achieved, and longer term bearish sentiment remains firmly in place despite Mario Draghi's recent failure to increase the ECB's bond buying program which the market had been expecting, and has led to a strong move higher in the short term.
For both the British pound, and the Aussie dollar, both currencies continue to remain bearish, with the first falling on weak economic data and likely to continue so, with the latter given a helping hand from the RBA and the continued weakness in commodities.
The Canadian dollar too is likely to remain under pressure for as long as oil prices continue to decline.
Finally, to equity markets which are now reaching a point of exhaustion in the US, and certainly from a technical perspective are building very solid ceilings of resistance to any further short-term advance. For the YM (Dow Jones futures) the level is being created around the 18,000 price region, and to date we have not seen a meaningful break and hold of this price point.
The sisters, namely the NQ (NASDAQ futures) and ES (S&P500 futures) too are at key resistance price points, with the NQ attempting to break through the 4750 region, and whilst the NASDAQ Composite has been leading stocks higher throughout 2015, this index too appears to be running out of momentum as congestion builds at this price region.
In summary whether you are a trader or investor 2016 promises to be another vintage year.
OPEC recently announced its intention to continue with its current crude oil production policies – in other words, the crude oil glut remains at least through June, 2016. Instability will continue to roil oil markets for the foreseeable future. The timing on Iran’s return to the oil market along with questionable predictions for the amount of oil it will dump on the oversupplied market will factor prominently into 2016 oil pricing. Another key concept to remember as we head into 2016 is that OPEC nations are in the business of making money. Oil rich nations like Saudi Arabia, Kuwait, and the UAE are intentionally overproducing to lower the price of oil and devalue petroleum assets worldwide. This is a strategy to increase their long-term profits. The big question for 2016 is: When will we see prices begin to recover?
To foresee that turnaround, keep an eye on the major players and what moves they make. When companies like ExxonMobil (N:XOM), Chevron (N:CVX), and Valero (N:VLO) begin to acquire assets from distressed companies in shale oil fields – or buy up smaller shale companies themselves – that is a sign that the price of oil soon rise. Other key indications will be well-capitalized national oil companies, like Saudi Aramco, purchasing strategic assets. Responsible energy investors need to follow these national companies as important barometers of the greater energy market, even though they are not traded on the exchanges. These companies are using this period of prolonged low crude prices to expand their contracts in Asia, boost their refining endeavors, capitalize on cheap financing to fund energy-infrastructure expansion, and purchase under-valued foreign assets. They will not begin to cut back on crude oil production until they have made the strategic long-term investments they seek, and they, more than anything else, determine the price of crude.
Meanwhile, in the current market conditions, refineries can be a profitable area. Despite government regulation in the United States that makes pipeline construction difficult, railroads are not a profitable sector. With a new administration, however, the anti-oil infrastructure policies may change and, towards the second half of 2016, pipelines may emerge as a profitable option. With continued low crude oil prices, decreasing global passion for climate change, and potentially a Republican administration in the White House, investors should be wary of renewable and clean technology in the long term. Current wind, solar power, and electric charging technologies largely require government assistance to appear profitable, and as more government scaffolding is removed in 2016 and in the following years, the long-term viability of these projects will be put to the test.
In last year’s outlook, I argued that the consensus EUR/USD short trade was becoming too crowded and that the increasingly common calls for a move down to parity (1.00) were way off base. Looking back, the big drop in January and February caught me off guard, but for what it’s worth, EUR/USD was essentially steady around 1.10 for the last ten months of the year.
For 2016, I’m going back to the well to make a contrarian case for a EUR/USD bounce. While the widely-discussed monetary policy divergence between the Federal Reserve and European Central Bank could limit any topside, the divergence may not be as extreme as many traders expect. Inflationary pressures are still nonexistent anywhere in the developed world, so the Fed may not be able to move as quickly it hopes Meanwhile, economic data in the Eurozone has quietly been improving of late, potentially limiting the scope for further easing from the ECB. At the same time, the short EUR/USD trade is once again extremely crowded, with the CFTC’s Commitment of Trader data showing that speculative traders are short over 200k EUR/USD futures contracts.
Albert Einstein once observed that the definition of insanity is “doing the same thing over and over again and expecting different results.” Fortunately (or maybe unfortunately, depending on your perspective), financial markets are not nearly as deterministic as the physics that Einstein studied. Of course, it’s also said that there is a fine line between genius and insanity, and if EUR/USD rallies against all expectations in 2016, the traders who capitalize on the move will look like geniuses.
Part II: Is the 7-Year Equity Bull History?
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