4. Start of emerging markets recovery. For the first time since 2010, average annual growth in emerging markets should begin rising to 4.3 percent in 2016 from 4.0 percent in 2015. Excluding China, growth should pick up to 3.1 percent in 2016 from 2.6 percent in 2015. About three-quarters of emerging market economies could show signs of recovery by the middle of 2016, whereas Brazil could contract further to -3.5 percent as it struggles to climb out of recession. Investment likely will become the key driver of the emerging market recovery. Asset price returns of roughly 2.7 percent for external sovereign debt, 2.5 to 3.5 percent for emerging market corporate debt, and 1.0 percent for local currency debt are expected in 2016.
5. Interest rates: up from zero. The Federal Reserve is expected to carefully calibrate a rate hike over the next two years, with a 0.25 percent hike this month and three or four 0.25 percent increases in each of the next two years. Meanwhile, further quantitative easing is expected in Europe and Japan and a mixed bag of policies in the rest of the world. U.S. 10-year Treasuries could reach 2.65 percent, and the dollar should remain strong, rising by 4 percent to 6 percent. The confluence of modestly higher rates, a Fed liftoff, and more regulatory pressures will likely keep liquidity risks in bond markets at the forefront.
6. Divergent monetary policies: U.S. and China go separate ways. With the Federal Reserve set to raise rates and the People’s Bank of China likely cutting rates, divergent monetary policies will shape the rates and currency markets in 2016. More weakness in the renminbi (RMB) is expected, with the currency depreciating over 7 percent against the U.S. dollar in 2016. This could have negative effect spillovers on emerging Asian currencies and commodity markets.
7. Commodities under pressure. A strong U.S. dollar and restrained global growth could create downward near-term pressures on commodity prices – not just in metals, but also in energy and grains. Overall, commodity returns could be flat to down by as much as 3.7 percent next year. Oil balances are set to improve in the second half of the year, with the combination of global demand and lower non-OPEC output potentially pushing crude oil back up to $55 a barrel. Meanwhile, natural gas demand should remain robust, with the spread between gas and crude oil widening. Base metals will likely stay soft, with gold continuing to struggle as the dollar strengthens and rates rise.
8. Credit is complicated. Fundamental trends in the global credit markets are divergent, and there appears to be no single global credit cycle. Optimism is highest for U.S. high grade, with 3 to 4 percent of excess returns expected next year. The bear market for U.S. high yield continues, with expected total return losses of 2 to 3 percent. Persistent yield differentials between U.S. and global corporate bonds are expected to force global investors into the U.S. market, and with potential returns as high as 6 to 7 percent, 30-year corporate bonds could deliver equity-like returns in 2016. It could be a tough year for credit in emerging markets, with stark divergence in returns from nation to nation. Still, the overall forecast for emerging market credit is positive, with a 4.0 percent total return for high yield and 2.5 percent for investment grade.
9. Global investment strategy. Global stocks are expected to rise by 4 percent to 7 percent in the next year, with equity markets in Japan (strength across the board), Europe (banks) and the United States (high-quality cyclicals) among the standouts. BofAML’s asset allocation calls are long U.S. dollar, volatility and real estate; short commodities and other credit sensitivities; stocks over bonds; developed markets over emerging markets; and investment-grade over high-yield bonds. And with Main Street bulls and Wall Street risks, the best ways to invest could be to buy what the middle class buys: mass retailers, regional banks and investment grade bonds.
10. U.S. housing recovery continues. Further expansion of the U.S. housing market is forecast for 2016, with housing starts of 1.275 million, reflecting a recovery in household formation. Existing home sales could increase by 5 percent in 2016, while new home sales see a more robust 10 percent growth rate. Home price appreciation could slow in 2016, with prices up by only 1 percent, a reflection of home price overvaluation relative to income. Though the rise in interest rates poses some risk to the U.S. housing recovery, the Fed’s go-slow approach should prevent a painful rise in mortgage rates. Long term, there are signs of a structural shift in the housing market toward renting over home ownership, and, in turn, an increase in multi-family housing construction.
