Posted on: 13 January 2016
When you start with a backdrop of high debt, low growth and low inflation, it’s unlikely to be a smooth start to the year. Indeed, having gone from a bullish outlook on the UK’s economic future in the last year or two, the Chancellor is himself warning of a “cocktail” of global factors that could derail the UK’s economic growth in 2016.
From what is happening on the oil and commodities front, to a closure of China’s stock market on the first official days of trading, 2016 has got off to a particularly bumpy start. Here we take a look at some of the big factors that will shape the economic outlook this year…
The China effect…
Already the big news this year has been China. It was forced to suspend stock trading after the Shanghai Index nosedived by 7%, as international investors reacted to ailing oil prices, China’s currency depreciation and geopolitical uncertainty. Obviously, it’s not just bad news for China and emerging market investors but the ripple effect on global markets has been considerable, with the FTSE, Dow Jones and the Nikkei all taking a big hit. And when the world’s second largest economy slows, it undoubtedly weighs on global economic growth.
However, the world’s economists cannot deny that China’s slowdown was, to some extent, to be predicted and an inevitable result of it moving away from being a manufacturing-led economy to a richer, consumer-led economy. In 2015, we endeavoured to prepare client portfolios as much as we could for difficult times ahead caused by slower global growth, and are as a result much more defensive as we head into the New Year.
Oil on troubled waters…
2015 has seen the oil price plummet. It has recently fallen below the $32 mark, reaching an 11-year low, causing massive consternation in the markets.
For UK consumers, the changes aren’t too drastic - you can now fill up your tank for 30% less than at the same time last year, but it is unlikely this will have a significant impact on consumer spending.
It’s the volatility of oil prices that is causing the biggest problem, particularly for corporates. Volatility makes it difficult to budget and forecast and has the knock on effect of corporates deferring investment decisions. Volatility has a dampening effect on economic growth, not just in the UK, but on a global level.
It’s all about the rates…
In 2015, everyone was looking at the Fed to take their lead on raising interest rates, asking ‘will they, won’t they’. Well, of course in December they did. The question remains, what level will rates get to in 2016 and beyond?
The Fed continues to be cautious and has been clear that it will not mechanically increase the rate at every meeting next year. In fact, by the time we get to Q3, we might only see two further interest rate rises of 0.25%.
And even though everyone is talking about interest rates climbing further north into 2017, this might not be the case. Certain economic variables could see the Fed reversing its decision and winding interest rates back. Why? For a start, the US consumer could retrench in 2016 and start reining in spending. Secondly, trading with external partners – particularly Europe with the Brexit question mark – is likely to be tricky. And emerging markets are continuing to have a torrid time in the context of low oil and commodity prices. So a number of reasons suggest that even though Janet Yellen et al would rather not drop interest rates next year, they might be in a position where they are forced to. And whatever the Fed does, the rest will follow.
Whatever the case, markets will start to factor in the uncertainty and will probably work on the basis that rate rises will be slower this year. But if rates rise faster than markets expect, markets will have to adjust and bond prices will naturally fall. If markets are right and rate rises are slow or even go down, not only will it raise questions around the credibility of the Fed but it could push the US into a recession.
Clouds on the horizon?
Often it is those surprising events that catch markets unaware and cause corrections, and we can’t be oblivious to the ongoing political crisis in the Middle East. Although centred on Syria and Iraq, the Iran/Saudi Arabia rivalry will continue to depress oil prices for a while as Iran attempts to win back market share from the Saudis following the lifting of sanctions by the US. And the refugee crisis and ongoing threat of terrorist violence will likely be a problem for Europe for many years ahead.
Nobody really knows the full extent a Brexit would have on the UK economy. The burden of renegotiating bilateral trade agreements with partners would be enormous and there would be a temporary halt on trade as this took place. From a political perspective, the UK’s role as a global player would be significantly weakened. And for the FS industry, from a regulatory standpoint it would add yet another layer of rules – most of the mega banks would probably move their HQs to other destinations.
2016 is likely to be colourful and it is certainly beset by uncertainty. Even given this outlook, at Duncan Lawrie we believe our client portfolios are in good shape having made them more defensive in 2015 to take account of volatility in global markets. We continue to select careful fund managers and if some of these issues play out, as we anticipate they might, we will be in a good position to take advantage of opportunities and factor them in to our long-term investment approach.
All data has been compiled by Duncan Lawrie from sources believed to be reliable. Full details of sources are available on request.
The comments and figures in this document are generally applicable but you should always take specific advice to suit your individual circumstances before taking any action. Errors and omissions excepted.
The value of investments and income generated may fall as well as rise, and investors may not get back the amount invested. Past performance is not a reliable indicator of future results.
 Blend of the words 'British' and 'exit' which refers to the possibility of Great Britain leaving the European Union.