Early in 2016, we’re still in the season of annual market forecasts – and the accompanying debate about whether investors should pay any attention to those forecasts, or ignore them altogether.
Myself, I’ve always found detailed, precise forecasts of limited value, particularly when they’re published in February after four to six weeks of market performance. Such forecasts are more about improving the odds of being right, and making the analyst/economists look good, rather than communicating insight.
I’ve always thought the point of forecasts shouldn’t be to try to pin down the exact number of the S&P 500, or oil, or the Canadian dollar, or housing starts, or whatever else you may be trying to predict. Rather, it’s to identify big-picture themes and issues that may impact your portfolio, so you can take steps to protect yourself.
In the 30 years or so that I’ve been working with high-net-worth (HNW) individuals, I’ve noticed this is something they do better than most. Most of them are in the habit of gazing into the future quite often. But they’re less concerned about coming up with an exact number for this or that market/asset/commodity/whatever. Rather, they’re much more concerned about the “36,000-foot view” of what’s going on. This is how HNW individuals consider annual forecasts: as a way of asking “What if …” It’s as much about protecting capital as it is about seizing opportunities.
Over the past couple of months, I’ve been speaking to many HNW individuals (both here in Canada, and in the U.S. through the TIGER 21 network) about some of the trends and issues on their radar screens. I’ve also spoken to many colleagues, analysts, portfolio managers, hedge fund managers and other professionals who work with HNW clients. Here is a summary of these expectations, along with my own insight and observations, written as of the last week of December, 2015.
Challenging times for Canada
Most HNW investors anticipate continued weakness in the Canadian economy. And while opportunities are starting to emerge in the commodities sector (see below), most HNW investors remain cautious about putting too much money to work in Canada. This is a continuation of a trend that started last year, when HNW investors started to pare back Canadian holdings and allocate them elsewhere.
When it comes to Canadian real estate, many see an inflated/oversupplied housing market. Most believe (and I agree with them) that we’ll see real estate sour in 2016 – what we’ve seen so far is only the start of a topping process.
With consumer household debt to household income rates soaring to all time Canadian records, and the ability of major financial institutions to generate organic growth coming into question, we expect Canadian short-term interest rates will lag U.S. rates. This, of course, will put continued pressure on our loonie; we see it dipping below 69 cents (U.S.), and likely bouncing in and out of that level for most of the year.
Continued uncertainty overseas
Many HNW investors expect a difficult year ahead in most developed markets, with political/military conflicts creating uncertainty around the globe. We agree with them, and see many international economies unravelling.
While many HNW individuals believe the U.S. economy will continue to grow modestly, there is less optimism about the U.S. equity market. We believe the FANGs, for example (Facebook, Amazon, Netflix, Google), will make a major move lower, and this will contribute to a beginning of a U.S. bear market in 2016. Last year, FANGs were the main stocks keeping the S&P 500 afloat, and they likely need to be “ground down” to molars this year.
Emerging markets are something of an exception to this gloomy forecast. We expect them to find a bottom in 2016-17. But they will likely experience a very bumpy ride along the way – as they historically always have been. Some HNW investors have started to boost their allocation to emerging markets over the past several weeks, and we expect this to continue. throughout the year.
Beaten-down sectors will bottom and start to turn
After an annus horribilis for commodity producers, we are preparing for a gradual bottoming in 2016. Some HNW investors have become quite interested in commodities from a deep value perspective. While we’re not in the business of picking a bottom for any commodity (notoriously difficult to do), we have been busy identifying select opportunities, and expect to continue doing so throughout the year.
After a brutal 2015, the energy sector certainly has a higher probability of bottoming in 2016, and could start to rise at some point within the year. But it will be a volatile ride and a very slow process. We see U.S. light crude oil reaching lower before it starts its climb back to respectability. One area we’ve become very interested in lately in energy-related master limited partnerships (MLPs). After declining 55 per cent from their peak in 2014 to their early-2016 lows, we are starting to step into this sector within Q1 2016.
Gold-related equities hit a bottom in 2015. Deep value bargain hunters have stepped in near current prices. We continue to see value here, particularly in well-managed gold miners. This could be the year that gold finds an interim bottom.
Volatility strategies remain top of mind
One longer-term trend among HNW investors is the continued attraction of volatility-based strategies – long/short and market neutral funds in particular, and more broadly, the entire alternatives category.
We expect continued “smart money” flows into hedging strategies throughout 2016, and in such an environment, we expect active managers to start to outperform passive investments. If the year shapes up largely to what HNW investors expect, the argument for managers who can potentially add alpha in both up and down markets will become very persuasive indeed. We use a combination of both active managers and passive ETFs as optimal in this environment.
Most broad markets are still expensive, even after the toughest yearly start in the markets since 1928. However, there are pockets of value emerging, but you have to think and act in a contrarian fashion to benefit.
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