Our outlook for 2016 is to expect at best flat equity markets and more likely a meaningful correction. Simultaneously, bonds are unlikely to provide a hedge to falling stock prices as the correlation of bonds and equities is likely to be possitive (Shifting Stock and Bond Correlation):
Picture: Bond Stock Correlation Overtime:
Impact on US and Global Stock Markets:
The US dollar should continue to fly high with the Fed hiking US interest rates. That however is not necessarily good for anyone. The first Fed interest raise was modest and interest rates remain at historic low levels (See Picture above). The real question is how fast and how soon will further interest rate hikes follow. Interest rate hikes are likely to further suck liquidity from the economy, increase corporate borrowing costs, decrease sales of US goods abroad and ultimately depress US corporate profits due to lower sales and drive the US stock market lower. Pent up pressure and fears about political instability may further cause a run on both US and global stock market.
A strong dollar is also negative for emerging markets from Thailand to Chile, where we see the highest risk in 2016. Emerging market governments and companies that have accumulated overwhelming dollar-denominated debt are vulnerable to the relentlessly rising of the US dollar, which may push them into default and cause emerging market debt crisis further endangering the global economic outlook.
According to the Wall Street Journal, “Energy companies are some of the biggest borrowers. Brazil’s Petroleo Brasileiro SAhas issued $40 billion in dollar bonds since 2008. China National Offshore Oil Corporation borrowed almost $14 billion in greenback debt in the last four years. Petróleos de Venezuela SA has racked up nearly $21 billion in the past seven years. Although oil-firms’ income is largely denominated in dollars, plummeting crude prices are pushing up default risks.”
The European stock markets also do not look promising as the Greek crisis remains unresolved and structural economic fundamentals such as labor markets and social security reform remain unaddressed (European Stock Performance):