Now that 2015 is coming to an end, investors start thinking and planning on how they could make money in 2016. My opinion is to remain overweight European equities an underweight the US.
Some people argue that the situation in Europe and the US is not that different. Economists are forecasting a growth rate of 2.5% for the US and 1.7% for the Eurozone in 2016. However, the different direction in central banks’ policies makes European equities much more attractive. Going straight to the point, with rates on the rise in the US, I find it hard to see the US economy grow by 2.5% in 2016.
If growth in the US starts to falter due to the initiation of a rate hike, I would expect the value of the Dollar to weaken as two rate hikes are already seemingly priced into the currency. This would result in a stronger Euro putting downward pressure on European sales and in turn on the 1.7% growth rate forecasted for the Eurozone.
With China slowing down and the brakes put on US economic growth, I expect the ECB to intervene once again and increase quantitative easing in Europe. That is your catalyst to be long European equities heading into 2016.
Though markets will remain as volatile as 2015. To make a good return on investment, an investor must give more importance to technical analysis. Further detail about my reasoning below:
US Stocks - Underweight
I am underweight US stocks heading into 2016. US markets have rallied 150% since the Federal Reserve announced its quantitative easing program in November 2008. The program ended in October 2014. By then the Fed had pumped over $4.5trn in the US economy.
Now we are seeing a reversal in the policy. From an expansionary one to restrictive policy. I am concerned that the rate hike in the US will have negative repercussions on the US economy because a reversal in policy when China is slowing down and Europe just started to show signs of a recovery, is not ideal.
What I’m most concerned about however is operating margins being under pressure. So far, US companies managed to increase margins as costs continued to decline. However, I expect 2016 to be different. With margins already showing signs that it is difficult to continue increasing above the current levels, I do not see further capital upside in US stocks.
In Q315, we have already seen that margins are not expanding. With employment and borrowing costs expected to pick up coupled with a strong Dollar will just add additional pressure to margins, not making the US equity markets the right place to be.
On a positive note for US markets, the slowdown in growth could result in companies giving cash back to investors rather than use it to invest in the company. This could come in the form of share buy backs or increased dividends.
However, everything is pointing towards an outperformance of Europe over the US in 2016.
European Stocks - Overweight
I remain overweight European stocks in 2016. So far European economic data has been improving. However, I don’t expect data to continue to strengthen unless the ECB increases its bond buying program.
A weaker Euro, weaker commodity prices and ECB intervention have all led to an improvement in European economic data in 2015. However, this is already priced in and for economies to continue to improve in figures, economies need more stimulus.
With the 1.7% growth forecast for the Eurozone under pressure due to further weakness in China and potential weakness in the US, Draghi would have to intervene. There is also the argument that commodity prices could increase in 2016. Although I do not see a catalyst for an increase in commodity prices in 2016, history shows that the worst performing sector for the year recovers in the following year. And consensus is calling for a recovery in energy stocks. I cannot disregard this possibility and it will only result in an increase in the cost base of companies.
These all lead to my base case scenario for 2016. The ECB will do what it failed to do in December 2015 and increase quantitative easing in Europe. This would result in an increase in price multiples and in turn a rally in equity markets.
Conversely, if what I expect doesn’t happen, and the ECB does not increase quantitative easing because data continues to improve, I expect to see an improvement in profitability going forward which should sustain the rally in European equities throughout the year.
As opposed to the US, I do not expect the cost base to increase at the same rate as the growth rate in sales due to the high unemployment rate in the Eurozone.
With sales expected to increase and costs remain maintained, I expect 2016 to be a positive year for European companies.
Keep on holding to your European equity positions. The best is yet to come. Happy Christmas.
This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.