by What central banks do – and how their policies diverge from one another – will continue to drive financial markets in 2016, impacting fixed income markets and creating opportunities for equity investors in places where policy is easing, according to the 2016 Investment Outlook from Credit Suisse’s Private Bank. The Federal Reserve seems almost certain to raise interest rates for the first time since 2006 in December – and, Credit Suisse believes it will raise them three more times in 2016. The presumed hike will mark the first time since 1994 that the Federal Reserve has moved in the opposite direction from the European Central Bank in the same month. (The ECB cut deposit rates from -0.2 percent to -0.3 percent December 3.) Meanwhile, the Bank of England is likely to raise interest rates in the first half of 2016, while Japan still has an easing bias. All of which adds up to the fact that in 2016, the effect of central banks’ policy on financial markets is going to get a whole lot more complicated.
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Ashley Kindergan considers the following as important: Bank of England, Bank of Japan, bonds, Central Bank, divergence, equities, European Central Bank, Federal Reserve, fixed income, Investing: Features, Monetary Policy
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What central banks do – and how their policies diverge from one another – will continue to drive financial markets in 2016, impacting fixed income markets and creating opportunities for equity investors in places where policy is easing, according to the 2016 Investment Outlook from Credit Suisse’s Private Bank. The Federal Reserve seems almost certain to raise interest rates for the first time since 2006 in December – and, Credit Suisse believes it will raise them three more times in 2016. The presumed hike will mark the first time since 1994 that the Federal Reserve has moved in the opposite direction from the European Central Bank in the same month. (The ECB cut deposit rates from -0.2 percent to -0.3 percent December 3.) Meanwhile, the Bank of England is likely to raise interest rates in the first half of 2016, while Japan still has an easing bias. All of which adds up to the fact that in 2016, the effect of central banks’ policy on financial markets is going to get a whole lot more complicated.
For starters, it’s going to make life a lot more challenging for fixed-income investors, Credit Suisse’s Investment Solutions & Products team believes the Fed’s impending rate hike, combined with a gradual uptick in both global growth and inflation, will finally end, if not reverse, the decline in global bond yields since the financial crisis – particularly in the United States and United Kingdom. If that’s the case, 2016 will offer little upside potential for government bond returns, as coupon contributions will be insufficient to absorb the impact of even gradual yield increases. Investors in German and Swiss government bonds face an even worse challenge, as those countries’ short-term bonds are already paying negative interest rates, meaning that investors who hold notes to maturity will lose money. Credit Suisse’s Investment Solutions & Products team predicts that returns will be “unattractive or even negative” for sovereign bonds in Europe, the U.K., and U.S. for the next three to five years.
While fixed income could find itself under more pressure than equities next year, there are a few bright spots. Corporate bond yields have been rising since the summer, as concerns about global growth and rising volatility have contributed to investor jitters about risky assets. “Unlike government bonds, corporate yields now have better prospects of offsetting at least a slow trend rise in interest rates,” Credit Suisse’s analysts write in the outlook. In investment-grade credits, floating-rate notes may appeal as a hedge in case the Federal Reserve raises interest rates faster than currently expected. Similarly, inflation-linked bonds offer protection against the possibility that inflation will rise faster than investors anticipate in the year ahead.
For fixed-income investments that offer potential returns to rival equities, investors will have to turn to high-yield bonds. High-yield bond spreads are above their 25-year averages, largely due to fears about corporate debt defaults. The 102 global corporate defaults in 2015 were the most since 2009. Looking forward, a full 187 companies covered by Standard & Poor’s have both solidly junk ratings (B- or worse) and a negative outlook, while Moody’s counts 239 companies in the same situation (B3 or worse rating and negative outlook). Those are the highest tallies for both agencies since 2010. While Credit Suisse believes rising interest rates will increase the number of defaults, they also think the current spreads on bonds as of December 11 with B (6.77 percent) and BB (4.28 percent) ratings are pricing in this risk. Those who desire added security should look at senior loans – corporate debt that is secured by collateral. They pay slightly lower interest than unsecured instruments, but investors are more likely to be repaid in the event of a default. From a regional perspective, European high-yield bonds have a lower risk of default than those in the United States, and the European Central Bank’s continued commitment to easing should put less pressure on European bond prices than those across the Atlantic.
Equities, simply by virtue of not being bonds, could be an investor’s best friend in 2016. Earnings growth was negative in developed markets in 2015, but Credit Suisse believes it will move into the mid-to-high single digits next year, supported by a slight uptick in global growth. Valuations in the developed world are somewhat above their historical averages on a 12-month forward price-to-earnings basis, (15x compared to 16.2x), but relative to bonds they look low, with the gap between equity and government bond yields standing close to historical highs.
Credit Suisse advises investors to keep cash on hand to deploy in the event of volatility-related pullbacks or marketplace events that might send investors running from bonds into stocks, such as news of rising interest rates or illiquidity in fixed-income markets. The first such opportunity will likely come before the New Year, if the Federal Reserve raises interest rates in mid-December as expected. In terms of regional stock selection, the bank’s analysts recommend that investors take advantage of monetary policy divergence by choosing Swiss and European stocks, which should benefit from ongoing easing by the European Central Bank. In the same way, investors may want to steer clear of sectors that are vulnerable to rising rates, such as utilities, and look instead to those with strong secular growth potential, such as technology and healthcare. More broadly speaking, the bank prefers the equities of those firms that are taking advantage of cash sitting on their balance sheets through share buybacks, initiating or increasing dividends, or mergers and acquisitions.