2015 Scorecard – and what to expect in 2016

2016

Today we’re going to look at the prospects for 2016, which is set up to be a year of change. We’ll also look back to what we said might happen in 2015.

2016 – a year of change?

It’s easy to come up with a list of things that have the potential to make 2016 a year of change:

  • the first interest rate hike in a decade
  • the oil and commodities bust
  • the emerging markets slowdown
  • the Brexit referendum
  • the US presidential election

But before we look at what might happen in the coming year, let’s look back at what we said might happen in 2015.

15 things that might have happened in 2015

We ended last year with a list of fifteen things that might happen in 2015.

I’ll score myself out of 2 for each item, with two points for something that has pretty much happened, and zero for something that didn’t come close.

  1. US divergence
    • The Fed interest rate hike earlier in December can be read as the final proof that the US is at a different stage in the cycle from Europe and Japan.
    • I’m not sure that the hike is entirely justified, but the US is definitely ahead, with the UK probably closest to it. I’m giving myself 2 points here.
  2. China slows
    • Another two points. The only debate here is how much China has slowed, and what will happen next.
    • The predicted knock-on effects on global exports and the exporting of deflation have also come to pass.
  3. Japanese QE continues
    • Another two points – Abenomics continues, with mixed results.
  4. US rate rise
    • Another two points, though only just.
    • I also pointed out that it might not be needed. Will it stick?
  5. UK rate rise
    • On balance I thought this wouldn’t happen, so I’m banking another 2 points.
    • I also thought deflation was likely (see below).
  6. Bond market fails to crash again
    • Another two points. We feel a bit closer to the end now, and there have been liquidity-exacerbated problems with a few high-yield (junk) bond funds.
  7. Oil price remains low
    • Another two points. No sign of a turn-around here in the short-term.
  8. Grexit?
    • A year ago we were waiting for the January 2015 snap election, with Syriza top of the polls. Grexit looked a real possibility.
    • I didn’t say it was nailed on, so I’m tempted to take a point.
    • But I also failed to see the Germans allowing QE in Europe, so let’s call this zero.
  9. Political problems in Europe
    • There have definitely been problems, but the thrust of my prediction was that the risk of an EU exit (other than Greece) would rise.
    • This is definitely the case, even if you only consider the UK. We recently had our first opinion poll ever in favour of exit.
    • I’m going to take a single point here, as I feel guilty that the reason for the change is ISIS terrorism and the Syrian refugee crisis, rather than pure economics.
  10. Deflation
    • Two points here, there has been intermittent deflation in the UK and Europe, helped by the continued weakness in oil and commodities.
    • Luckily it hasn’t been serious enough to cause any economic problems of its own.
  11. UK pension reforms
    • No strong predictions here – I thought that some people might abuse the reforms but most would not.
    • I also thought that final salary scheme holders might become jealous of their defined contribution friends and colleagues who could access their money immediately.
    • The queue of unresolved “persistent client” cases is testament to that.
    • Since the predictions were weak, I’ll just take one point
  12. UK election
    • I predicted the SNP over-running Labour in Scotland and the Liberals being obliterated.
    • But I fancied a coalition rather than an outright win for the Tories, so I’ll just take one point.
  13. UK tax hikes
    • On the back of my coalition prediction I went for tax rises.
    • We’ve had them – along with some cuts – but not in the places I expected. Another single point.
  14. UK house prices stall
    • Another mixed bag. I thought that the top end would slow down because of stamp duty, but feared this spreading out to the regions.
    • I also predicted that regulation might reduce the contribution from buy-to-let.
    • So one point again.
  15. P2P lending goes mainstream
    • I thought that the introduction of a P2P ISA would catapult this product into the mainstream. The ISA was delayed for a year and though volumes have risen, it isn’t mainstream.
    • There’s also the risk that this market is going to be taken over by the institutions, to become just another channel, rather than a true peer revolution.
    • I’ll be brutal and take zero here.

So how did I do?

  • I make it eight wins, five draws and two defeats, or 21 points out of a possible 30.
  • That’s 70%, so pretty good, with some room for improvement. Which is exactly how I like it.
See also:  Weekly Roundup, 3rd April 2018

Of course, this is a self-assessed exam, so perhaps I’ve been too easy on myself. If you disagree with any of the scores, let me know in the comments.

Now on to 2016.

What to expect in 2016

Now that I’m a year into the blog, I’m going to refine my predictions somewhat.

Instead of general macro bets, I’ll focus more on practical investment “advice”.1

I’ll get the macro stuff over with first.

Interest rate “policy” in the UK seems to be designed to keep the markets on their toes.

  • “Forward guidance” contradicts itself every few months.
  • I think that the economic conditions don’t support a rate rise, and they won’t improve enough to make one necessary.
  • I’m not sure I can see a political reason for a rate rise, either.
  • So I’m going to predict that we won’t get one.

We can also expect more changes to the UK  pension system:

  • higher rate income tax relief will go
  • but will it be replaced by a flat rate or by a Pension ISA?

So fill your boots before April.

Now onto the asset classes.

Stocks

Stocks are worth the sum of their future earnings, discounted by an appropriate long-term interest rate (the 10-year government bond, for example).

  • So earnings are on their way down, in the US at least, to judge from 2015.
  • But forecasts for 2016 are better, as they are in Europe, where 2015 was a very bad year.

Interest rates may start (or in the US, continue) to rise, diluting the impact of better earnings.

  • Further deflation would mean fewer, smaller interest rate rises, while consumer-driven inflation would produce more.
  • In the ideal world of economic theory the effects from interest rates would cancel out the consumer-driven earnings effects.

So a starting position for stocks is that they might do okay.

  • But it’s possible that rising wages and interest rates, deflation from commodity prices, and weak demand from China could drag this forecast down a bit.
  • On balance, stocks should be okay but not great. And there’s a risk they will be poor.

Regionally, emerging markets and Europe look better than the US. The UK looks fairly valued.

In sector terms, rising rates might eventually push investors out of defensive growth stocks and into true value stocks.

Bonds

We’re 30-plus years into a bull market for bonds, and each year we have to consider whether this will be the year that it all comes to an end.

  • Major institutions hold fewer bonds than they used to, since regulators made them expensive to hold.
  • This in turn means reduced liquidity.

If you’re a distressed seller of an illiquid asset, it’s worse than being trapped in a crowded theatre that’s on fire. The only way you can get out is by persuading someone outside to swap places with you. – Tim Price

But a full-on crash remains unlikely.

  • Pension funds and insurers remain keen buyers of bonds, supporting prices.
  • The more probable outcome is that bonds will slide by 1% or 2% per year (after inflation) for a long time – perhaps another 30 years.

But what will be the trigger, and will it happen this year?

Perhaps that’s the wrong question. At current valuations, bonds are “return-free risk” and should be avoided.

Commodities

Oil looks set to stay low.

  • There no sign of OPEC doing anything about supply, and demand remains weak.
  • The recent climate change agreement and the prospects for autonomous vehicles suggests it may remain weak.

As in 2015, this is good news for importers like Japan, and bad news for exporters.

  • It also acts as a price cut for consumers
  • With inflation low, this is bullish for consumer spending and Western economies.

Producers will need to go bust before we see a bottom.

  • Will that be at $30, or $25, or $20 a barrel?

The same is true for industrial metals, particularly iron.

  • Here too a company failure could mark the bottom.
FX

The first thing to think about is how long the oil producers can survive with crude below $40 a barrel.

  • Saudi Arabia needs $85 a barrel to balance its budget and $60 to balance its current account.
  • It has large FX reserves and can survive for some time, but smaller producers will be under pressure to devalue or un-peg from the dollar.

The same applies to China, for different reasons. The construction boom has created excess capacity in steel and lots of debt.

  • The yuan will come under pressure against the dollar, and China is looking to benchmark its currency against a basket of currencies – perhaps the IMF’s SDR, which it has just joined.

Of the major currencies, the dollar is probably high enough, but could be supported by more interest rate rises.

See also:  Weekly Roundup, 9th June 2015

It’s hard to form a clear picture on the pound or yen, though the latter might rise if the Japanese economy does well.

But the euro faces dilution from QE, while this has stopped in the US.

  • To reach UK and US levels, another four years of QE will be needed. So the euro could slip (and euro stocks might do well).
  • And the threat of a euro break-up, fuelled by the market realisation that France and Italy may never repay their debts, will remain.
  • This makes euro trades complicated.

The Swiss Franc is a promising currency to short, since its current value makes Swiss exports uncompetitive.

Potential surprises

Professional investors – and the institutions they work for – regularly carry out what are known as “tail-risk” analyses.

  • They look at what would happen if various kinds of Black Swan events took place during the next year.
  • As you might imagine, this kind of thing as been taken more seriously since the 2008 financial crisis.

Last year wasn’t a vintage one for shocks.

  • Some would include the Swiss National Bank dropping its currency peg to the euro in January, others the problems in junk bond funds in December.
  • You might also add the constant delay to the first US interest rate rise, or the ECB decision not to add to its stimulus programme at the end of the year.

Yet others would say that all of these events could have been predicted.

  • This is the problem with prediction – how do you anticipate the events that are difficult to anticipate?

So let’s think about not possible Black Swans, but some dark grey ones:

  1. A crash in China – rather than a gentle slowdown – would be problematic for most of the world’s economies.
    • Serious devaluation of the Chinese currency could have a similar effect.
  2. Since no-one expects it, inflation might return – though it’s difficult to see how – and trigger sharper interest rate rises, and a bond market crash.
  3. A fall in the dollar – or an increase in the Chinese growth rate, perhaps as a result of a stimulus programme – could see commodity prices rise.
  4. The oil-producing countries might act together to cut production and raise prices, perhaps forcing a short squeeze on energy bears.
    • The problem here is US shale swing production, which is unlikely to disappear.
  5. A vote for Brexit in the forthcoming referendum would have looked like a big surprise twelve months ago, but the result now looks too close to call.
    • But it would certainly introduce lots of uncertainty into the system, with potentially serious consequences for the UK economy and for sterling.
    • This in turn might cause foreign investors to prop up the UK stock market and the London housing market.
  6. On the other side of the Atlantic, someone other than Hilary Clinton might win the US Presidency
    • Trump is the obvious gray swan, but Ted Cruz has some radical tax plans (flat income tax, VAT instead of corporate taxes) and would link the dollar back to the gold standard
    • this would definitely impact the dollar, with knock-on effects elsewhere
  7. I suppose we need to consider war and terrorism here:
    • there could be aggression from Russia or China; there probably will be terrorism from IS
    • but what effect will this have on the markets, and should you do anything other than hold 5% to 10% in gold (if you are so inclined)?

Let hope that we’re just playing devil’s advocate with all of the scenarios here.

What will I be doing in 2016?

The most important thing to say is that I will be doing more that I did in 2015, when setting up this website occupied too much of my time.

  • Given the boring prospects for passive investing in 2016, my plan is to actively trade more than in the last couple of years.

At the same time, I need to move a fair amount of money between accounts as part of my gradual transition from the accumulation phase to the decumulation phase.

  • This will involve working out which accounts are cheapest for active and passive investment during decumulation, across a range of products (OEICs, ETFs, investment trusts and shares).

I plan to spend a lot more time on the SmallCap Growth (AIM) portfolio, and to  set up two more portfolios:

  1. Dividend portfolio
  2. Momentum (trend-following) portfolio, probably through spread bets

I hope you’ll follow along as I do so.

Until next time.

  1. This is not advice, since I don’t know your personal circumstances – this is intended to be educational and possibly even entertaining – always DYOR []

Mike is the owner of 7 Circles, and a private investor living in London. He has been managing his own money for 35 years, with some success.

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2 Responses

  1. Martin says:

    Hi Mike,

    Pension reforms are a bit concern for those of us who have started late and are trying to make up for lost time in terms of contributions. Any ideas on the timetable for changes? I have read we should expect changes in April, but surely the whole industry and savers will need time to gear up to any change well in advance? Also what about those who do salary sacrifice – are there any indications as to whether this will be treated in the same way with a flat rate of relief for all?

    thanks Mike,

    • Mike Rawson says:

      Commentators seem to be split on this one. Some say the changes will come in from April 2016, others say April 2017.

      Restrictions on salary sacrifice seem likely but nobody seems to know exactly how it would work.

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2015 Scorecard – and what to expect in 2016

by Mike Rawson time to read: 8 min