Berenberg outlook for 2016: equities remain preferred asset class
- Global economy to expand 2.5 percent
- DAX at 11,800 points by the end of 2016
Hamburg. Berenberg expects the United States and Europe to go on expanding through 2016, albeit at a restrained pace. Seven years after the major financial crisis, many people’s behaviour continues governed by caution. Germany’s oldest private bank is predicting global economic growth of 2.5 percent in the coming year, with expansion remaining stable in the West and crises petering out in some emerging markets.
“Private consumption will be the main economic motor on both sides of the Atlantic,” says Berenberg Chief Economist Dr Holger Schmieding. “While the tailwind from the collapse in oil prices slowly abates, the sustained increase in employment is likely to go on pushing consumption in the Western world.” The economy in the United States is in such good shape (with growth of 2.6 percent forecast for 2016) that the Federal Reserve can now start cautiously raising its benchmark rates. The reforms enacted in peripheral Europe coupled with the appropriate monetary policy pursued by the ECB will provide further impetus to the eurozone economy: Berenberg expects to see growth total 1.6 percent in 2016. China is continuing to modernise. With growth starting to tail off, the economic momentum is shifting ever more from the in-places state-directed capital spending on industry and infrastructure towards modern services. “Even if the transition to more sustainable growth is practically impossible without some friction, we still consider a hard landing to be very unlikely.”
Germany is set to remain an important driver of growth in the eurozone. “The signals for domestic demand in Germany are set to green. The labour market is brimming with confidence and the prospects for German exports may also brighten again at the beginning of 2016,” comments Schmieding. Following a slight dip in growth over the winter, Berenberg believes that economic output might increase by 1.7 percent on average over the year as a whole. In light of the fiscal impetus from the accommodation and integration of refugees totalling at least 0.6 percentage points of GDP, economic growth might even turn out somewhat higher in 2016.
Price trends are still restrained. With the price of oil remaining stable rather than falling, inflation will pick up a little, to nearly 1 percent in Europe. “Economic risks are less pronounced than in previous years. All the same, we need to keep an extremely close eye on political risks, including the risk that right-wing populist parties could jeopardise the European cohesion that forms the foundation for our prosperity. One of these risks is the British referendum on EU membership,” says Chief Economist Holger Schmieding.
Currencies: Period of euro weakness set to persist
Even though the euro crisis has been resolved, the euro exchange rate remains under pressure. “The euro is undervalued at the present level. The ECB’s expansionary monetary policy will again serve to depress the currency in 2016. Nonetheless, the euro should gradually return towards somewhat fairer valuations during the course of the year. That said, it is possible that the lows seen in 2015 will be tested again at times,” states Schmieding.
Equities: Bullish trend not over yet, but upside potential appears limited
The interaction of persistently low interest rates with a largely stable economy is positive for the capital markets. Global economic growth seems likely to follow a steady trajectory again in 2016. Whereas the United States and Europe will benefit from strong domestic economies, there are initial signs of stabilisation in China. This forms the foundation for corporate profits to expand by around 8 percent, thus also defining the price potential on the markets. “Where valuations are concerned, equities should now be considered fairly valued in the light of the bullish trend over recent years, although they are set to remain our preferred asset class relative to bonds,” says Markus Zipperer, Head of Equities in Berenberg’s Chief Investment Office.
The regional preference is clearly for eurozone equities, followed by the United States and emerging markets. “The economic recovery in the euro area is still well below par by global standards in the wake of the sovereign debt crisis. The catch-up potential in corporate profits and the attractiveness in valuations are correspondingly large. The weak euro and a low oil price are providing additional momentum in this context,” says Zipperer. In the United States, on the other hand, the cycle already seems to be well advanced in the seventh year of the recovery. Given a labour market close to full employment, there is a risk that rising wages will have a negative impact on corporate profit margins, serving to depress growth: one factor that is not covered by the valuation. “For the emerging markets, we remain cautious despite the first signs of hope from China and lower valuation indicators.” The prospect of rising interest rates in the United States coupled with the persistent weakness in commodities represents a considerable headwind.
For diversification reasons, and to leverage the differing correlations, efficient combinations with other asset classes like bonds, alternative investments and also cash are certainly useful with long-term considerations in mind. “Active diversification across various different asset classes leads to a high-return performance over time and stabilises the portfolio in turbulent times.”
Fixed income: Divergent monetary policy
The monetary policies of the major Western central banks are diverging ever further. Whereas the Fed is about to start raising interest rates again in the United States, with the Bank of England likely to follow suit in spring 2016, the European Central Bank has spread its monetary safety net even wider in response to persistent deflation.
“We expect yields to rise moderately as the year wears on and believe that 1.10 percent is probable for ten-year Bunds at year-end. The case for slowly rising interest rates is built mainly around the Fed being about to reverse direction again shortly, raising its benchmark rates in four tiny steps to 1.25 percent by the end of 2016. This will lead to rising capital market rates in the United States, an effect that will not be without impact on developments on the German bond markets. In addition, the pace of economic growth in the eurozone is set to pick up in 2016, helping to restore inflation to the positive side on a lasting basis,” says Schmieding.
It is important not to discriminate against bonds in the portfolio setting, employing them instead as one element of an efficiently diversified portfolio. “We recommend short to moderate average maturities for bonds. We prefer corporate bonds over sovereign bonds,” states Zipperer. “In addition, when risk diversification and yield optimisation are taken into account, European high-yield bonds with a relatively short remaining maturity offer very attractive returns compared with corporate bonds. We also recommend less vulnerable, euro-hedged corporate bonds denominated in US dollars with a non-investment grade rating that offer slightly higher yields than European bonds even after the cost of hedging. Hard currency bonds issued in emerging markets and bonds issued in high-yielding frontier markets still look promising in the longer term. However, a higher price range does need to be taken into account.”
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