The Big Picture

We were forced to wait 50 weeks in 2015 for the Federal Reserve to hike its key interest rate for the first time in nine years. The angst was so great over 2015 since, at this time last year, there was talk of the first hike occurring last March or at least last June. But those months came and went – and so did September!

The problem with the September meeting was not only that they did they not raise rates as most had expected but the Fed confused all by showing their concerns over global economic conditions. So it was a relief when the rate was finally raised by 0.25% in mid-December with no adverse reaction.

But the damage had already been done. Our market all but reached 6,000 in March from 5,400 this time last year, only to fall to nearly 4,900 near the end of 2015. Then Santa took control and swiftly helped the ASX 200 rise back above 5,300 to finish the year only about 100 points down for the year. Of course investors in our market would also have collected dividends and franking credits of about +6.3% which is very good when compared to holding cash – even allowing for the ???2.1% ‘paper’ capital loss on the price index.

It would be unfair to blame all of the mid-year volatility on the Fed. Oil prices fell sharply because OPEC took on the might of the US shale oil producers. By holding up traditional oil supply, they made the shale oil alternative marginal at best. But the Saudis seemed to have miscalculated the ease with which one can switch shale oil supply on and off. As a result, Saudi Arabia has now found itself with a material government budget deficit problem – and they now intend to hike petrol prices at home by 50% to help rectify the situation. That’s called irony!

Iron ore prices too collapsed – again largely because of an over-supply problem. The ‘Big Three’ producers deliberately put the squeeze on higher cost, smaller mines.

Whether or not ore and oil prices have bottomed is disputable but almost no one of note is predicting prices to rise substantially in 2016. But with the resources sector falling from 36% of our index at the end of 2010 to 16% now, iron ore and oil prices are increasingly less important for an Australian index investor!

At home the big banks came under the spotlight as they were forced by the regulator to improve their balance sheets, to be better able to withstand any future home price corrections. They did this by issuing more shares through ‘rights issues’ which naturally depressed prices. No major additional raisings are expected for at least the next few years.

So the main things to watch for in 2016 are interest rate changes at home and in the US. The Fed published its forecasts which point to four hikes of 0.25% in 2016 while the market is pricing in only two! This disconnect is likely to lead to some short bouts of volatility around Fed meetings.

At home, the Reserve Bank is now thought less likely to continue to cut rates in 2016. There is a chance of one more cut but no one of note is expecting any hikes in 2016.

Market fundamentals are largely fine but it will take some time for investors to feel confident. We are predicting above average returns for both the ASX 200 and the S&P 500 – but nothing stellar. Bond markets might take some buffeting as Central Banks around the world change, or do not change rates.

So our view of 2016 is much like that of a patient just having left the dentist. The build-up was worrying, the treatment not too bad – and now the novocaine is wearing off – with dental health having been restored.

Asset Classes

Australian Equities

The ASX 200 was up +2.5% in December with a strong ‘Santa’ rally from December 15th. Much of the market volatility and ‘fear’ are subsiding. Energy was one of only two sectors to lose but that loss was a massive ???7.5%. Industrials also fell, but only by ???1.2%. The two standout performers were Consumer Discretionary and Consumer Staples at near +7% each for December.

For the year, the capital loss on the index was ???2.1% but, with dividends, the total return was +2.6%. Even with dividends, Energy and Materials lost ???27.3% and ???15.7%, respectively, over the year. But five of the eleven sectors (Industrials, Discretionary, Health Property and Utilities) produced double digit gains.

Since the big four banks, BHP, RIO and Telstra didn’t make the cut for big gains, simple big-cap portfolios didn’t fare very well. But there was plenty of room for nimble fund managers to outperform.

Our forecast for 2016 is for a capital gain of about +11.5% and a dividend of just under 5%. We think breaching 6,000 is quite possible but we don’t think above 6,000 is achievable for long in 2016. We also believe that the ASX 200 is reasonably priced – unlike the US which we think is a little cheap.

Foreign Equities

While out index was up +2.5% in December, most other major indexes were well down: S&P 500 ???1.8%; FTSE ???1.8%, DAX ???5.6%, World ???1.1% and Emerging Markets ???1.5%. These results support our view that our market was particularly oversold in November.

Over the year there was no strong pattern with the German DAX up +9.6% and Emerging Markets down ???8.2% with Wall Street almost flat at ???0.7% for the S&P 500.

Our forecasts for the S&P 500 are for gains of 15% in 2016, we currently have that market under-priced by ???3.3%.

Bonds and Interest Rates

The RBA kept rates on hold again at 2.0% and the next meeting is in February. There is a modest chance of another cut in the first half of 2016 but the chance of a rate hike is minimal for 2016.

The Fed US rate (range) is now 0.25% to 0.50% and the official forecasts are for that range to rise by 1% in four moves (one each quarter) by the end of 2016.

Of course 1.25% to 1.50% is still a very low rate but markets might question the need for so many hikes when inflation is well contained and economic growth is moderate.

The UK seems to have put its thoughts for a hike on the back-burner for now.

Other Assets

Iron ore prices fell from around $70 / tonne to less than $40 over 2015. While they could fall further there does seem to be a bottom forming. But no one of note is expecting big gains in the price during 2016 – a moderate gain to $50 is certainly not out of the question.

S&P downgraded its oil price forecast last January by 30% to $55 for 2015 and by 23% for 2016 to $65. The price has already dipped below $40! There is a limit to how far prices can fall as they are not sustainable at below cost. So if prices have not yet bottomed they don’t seem to have much further to go.

Iran is slowly letting new supply onto the market after having been allowed back to play in the sandpit after sanctions were lifted. This new supply, and OPECs reticence to curb its supply, does not make a significant price hike likely during 2016. Of course consumers are better off from low petrol prices so there are some winners around.

Gold lost over ???10%, and our dollar fell around nine US cents against the US dollar over 2015.

Regional Analysis

Australia

Our economy is moderately strong and inflation is low. Unemployment and employment growth have been steady for much of 2015. The budget in the coming May looks to be in need of addressing our burgeoning debt problem.

It looks increasing likely that the government will go early to the people with some new strong policies. With the opposition down in the polls an early election might rid us of the dysfunctional government we have enjoyed since 2008 – and for the better.

The labour force data showed that +71,400 jobs were created in November and unemployment fell to 5.8%. Although these numbers are very strong, the underlying official trend numbers are improving at a far more modest rate.

The Mid Year Economic and Forecast Outlook (MYEFO) statement by Treasurer Morrison shaved a little off growth forecasts but Treasury is still predicting 2.75% growth in 2016/17.

China

China’s Purchasing Managers Index (PMI) for Manufacturing came in at 49.7 which is the fifth successive month below 50 which signals that, although growth is strong near 7% pa, growth rates are slipping a fraction. China announced more fiscal and monetary stimulus in December.

U.S.A

It follows from the rate hike that the Fed thinks the economy can withstand it. Nonfarm payrolls data reported +211,000 new jobs and unemployment is at 5.0%. This situation is quite close to full employment.

Of course the big problem in the US is the prospect of Donald Trump winning the Republican nomination for November’s Presidential election. Trump has massive popular support but his policies seem to centre on there being less problems if everyone carried a gun (even in Paris, he has reportedly suggested!) and the US rids itself of Muslims. And this man, if he becomes President has his finger on the button in the role as Commander-in-Chief! Trump is not moderate.

But economic growth continues to be stable in the US – the latest data being +2.0% for Q3, 2015. Inflation is well under control. US house prices rose by +5.2% in October from the corresponding month in the previous year. This gain is a far cry from the deflation experienced in 2006 and onwards.

Europe

The economy is showing some signs of life. Industrial Output was up +0.6% on the month. But there have been a million migrants crossing into Europe during 2015. Angela Merkel refuses to put a limit on how many migrants Germany will take. Apparently when Bosnians took that route, two families were each allocated to a myriad of small towns – and assimilation was quickly achieved.

Only half of the one million migrants into Europe during 2016 were from Syria and 20% were from Afghanistan. 98 per cent arrived by sea. 3,600 died in the process. While a humanitarian approach must be taken, just having a million a year swelling the EU population is not the answer.

After the Paris and Brussels terrorist activity, there seems to be a better internationally co-ordinated attempt to solve the problem. That can’t come too quickly.

Rest of the World

Although its economy is still struggling, Japan chose not to add to its stimulus packages in December. Russia could be looking at a recession in 2016 and the Azerbaijani ‘manat’, its currency, lost 49% of its value on one day in December! There are so many problems around the world but they seem unlikely to have any great impact on our investment decisions – unless, that is, you choose to invest heavily in Emerging Markets.

*Ron Bewley(PhD,FASSA)– Director, Woodhall Investment Research

Important information

This information is the opinion of Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management and may contain general advice that does not take into account the investment objectives, financial situation or needs of any person. Before making an investment decision, readers need to consider whether this information is appropriate to their circumstances.