The stock market was essentially flat for the month of November, and it’s up just 1% on a year-to-date basis. Not even close to the consensus gain of 10% that was called for by Wall Street strategists last January. So the question we want to ask this month is… what can we expect for December and beyond? For some thoughts on that, plus our official 6 month forecast, read on.
To begin our December 2015 market forecast, take a look at the daily chart of the S&P 500 covering the last 12 months. The dramatic selloff in August is slowly fading in the rear-view mirror as we put more distance between the dog days of summer and the optimism of the holiday season. We’ll try to answer the question of what lies ahead by looking at what’s likely to happen in the real economy as we move forward.
Report Highlights
- November was a round-trip that got us nowhere
- Global economy will continue to grow next year, but slowly
- Emerging markets depend on China, which is teetering on the brink of recession
- Commodities remain depressed with no let-up in sight
- U.S. recession risk is low, but not zero
November Recap
As the chart above shows, November was a round-trip that got us nowhere. The last few months have shown that volatility is a two-way street. After experiencing the first “correction” (i.e., a 10% decline) in four years, the S&P 500 Index rebounded sharply as the US economy proved resilient to sluggish global growth. Historically, equities rally sharply following corrections, and the late-2015 episode appears to fit nicely into that script. While volatility will likely remain higher than usual as the Fed prepares to raise interest rates, we see few signs that the US economy is at risk of entering into a new recession.
Global economy
While the US economic recovery remains on track, with an improving labor market and rising consumer confidence, the Eurozone is expanding at a more moderate pace, and Japan has fallen into a technical recession. Emerging market economies continue to be relatively weak. In China, government support measures are helping to stabilize the faltering economy. Inflation is low, and monetary policy is loose and stimulative in most countries around the world.
The world economy next year will probably be stronger than in 2015, according to the IMF and economists surveyed by Bloomberg. But “a return to robust global expansion remains elusive,” the IMF said in its October outlook. IMF economists expect global growth of 3.6%, up from 3.1% this year and about the same as the long-term average of 3.5%.
China economic growth will continue to slow but probably stay above “stall speed” of 6%. The U.S. will continue to outperform its European peers. With global demand looking a little soft, the price of money (interest rates) and the prices of oil and other commodities are likely to remain low. Central bankers Janet Yellen, Mario Draghi, and Haruhiko Kuroda will be in the spotlight as the Federal Reserve attempts to push rates higher and the European Central Bank and Bank of Japan look for ways to stimulate growth.
Emerging markets
The most important variable for 2016 is China, where GDP dipped below 7% in the third quarter of 2015 for the first time since the 2008-09 financial crisis. Developing nations that have come to depend heavily on China as a customer for their resources include Brazil, Chile, Indonesia, Malaysia, the Philippines, South Africa, Thailand, and Vietnam. But the world’s appetite for Chinese goods isn’t growing at the same pace anymore, and China has no urgent need for more of the infrastructure it’s been building.
The IMF projects that China’s growth will slow to 6.3% in 2016, from 6.8% this year. That’s below the pace China’s leaders said that they want. China may yet slide into recession, caused by excess capacity and high debt loads. With Russia and Brazil already in recession, a sharp slowdown in China would drag other emerging markets down. Most developed countries depend less on exports to China, so they will probably not experience recessions themselves but will merely grow more slowly.
Asset allocation
We still prefer stocks over bonds. Specifically, we prefer U.S. and European stocks over Emerging Market stocks. Rates will rise in 2016, which should place a cap on how much growth we will get from the global bond market.
Equities
We still have a slightly positive outlook on global equities, with a preference for developed markets. We are overweight Eurozone equities, where economic data is improving. We expect a continued rise in corporate earnings due to the uptrend in economic growth, low corporate funding costs, and persistent monetary support. We are also overweight Japanese equities, as a weak yen supports the earnings outlook, while QE remains a source of solid support. We are not very enthusiastic about emerging market stocks due to their weak economic backdrop and falling earnings, and UK equities, which are facing headwinds from a strong currency, and commodity exposure.
Forecast for the U.S. Economy
Moderate expansion – Probability: 70%
We expect a slight pickup in US real GDP growth over the next 12 months, but without help from China and the rest of the world, growth will be limited.
Strong expansion – Probability: 10%
US real GDP growth accelerates, rising significantly above 3%, propelled by an expansive monetary policy, improved business and consumer confidence, strong housing investment, and subsiding risks overseas. The Fed raises policy rates significantly more than markets are anticipating.
Growth slowdown – Probability: 15%
US growth continues at a sub-standard pace. Consumers save rather than spend the windfall from lower energy prices, while businesses lack the confidence to hire workers and boost investment spending. The Fed remains on hold.
Outright recession – Probability: 5%
Some combination of too much Fed tightening, asset deflation, or geopolitical events trigger the onset of a new recession.
Stock market outlook
The recent 12% correction in the U.S. stock market seems to be over. But we won’t have confirmation of this until the market makes a new high of 2,130 on the S&P 500. Until that happens, the correction is still technically in place.
Bond market outlook
We expect the 10-year US Treasury yield to trend modestly higher, reaching 2.5% by June, and 2.8% by the end of 2016.
Commodities
Commodity prices showed signs of stabilization over the last couple of months, but as long as China growth remains weak, we don’t expect commodities to move substantially higher for quite some time.
Key Recession Indicators
Our 6 Month Forecast
Current Asset Allocations
Summary & Conclusions
2015 is turning out to be a lackluster year for investors. The U.S. stock market is the best performing asset class this year, and it might repeat that performance in 2016. Commodities are in a slump, with energy depressed and no relief in sight. So what’s an investor to do? Stay invested, especially in the stock markets of developed countries like the U.S. and Europe. For those who feel bold, it’s o.k. to start nibbling in emerging markets, but don’t get ahead of yourself. China could fall into recession next year, and if that were to happen, emerging markets would be in big trouble.
Nibble on commodities if you must, but the same warning goes there too. The commodities markets depend heavily on China, and energy markets have shown very little promise of a rebound in demand.
The bond markets will be tested next year, as the Fed begins a new regime of tightening and raising. Janet Yellen says she will go slowly, but there is always a risk that political pressure may cause her to make a policy mistake.
Volatility has come down since the August stock market correction, but you should expect it to rise again during 2016 as geopolitical events and unsteady economic growth dominate the headlines.