CEO of Austin Capital Trust
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World economies will remain very fragile until the debt-deleveraging of the global private sector is completed. The global economy will move toward a more balanced and healthier equilibrium. As a result, the developed economies such as the United States and Western European countries should contribute more toward global growth than they have in nearly two decades. For these reasons Austin Capital’s view is a world economy in deceleration not a short term stagnation.
The U.S. market in 2016 will most likely be negative. The economy should not grow more than 1% to 2%. The S&P 500 Earnings are estimated between $125 to $130 but will not see any multiple expansion. We will not see a large fiscal spending like Europe and Canada and another spike in U.S. dollar will pinch the Multi-Nationals earnings. Canada may be the first Western Country to emphasize fiscal spending. It will force investors to change emphasis in what they own. Currently it’s been a great environment for the financials and banks in Canada and horrible for energy stocks and western Canada. With infrastructure fiscal spending the western side along with energy companies should do better. C$1.33 should move to C$1.10 to possibly parity to U.S. dollar. Most of the stock sectors like healthcare and tech are very well owned. The unloved sectors, like material or energy are probably the sectors that will do well anticipating the next upturn.
U.S. Interest Rate
I cannot find much economic justification for further Fed rate hikes. With over $6 trillion in Treasuries owned by non-U.S. holders including China and further depreciation of the Yuan possible, the dollar will automatically get upside pressure. If the dollar further appreciates from another rate hike, we will most likely see a collapse in Emerging Markets and commodities. In most estimates, China’s GDP is about 3% to 4% not the print 7%. The danger of further depreciation of the Yuan is that other Asian countries may follow suit which will be counterproductive race to the bottom. I believe China is interested in buying oil at $32 a barrel but it is also highly dependent upon where the dollar goes. If China devalues the Yuan again the dollar value of oil will appreciate.
Oil and Gas
The counter to the pressure in oil is the risk profile in the middle east. I think the risk of a conflict is going to build very fast. There is no premium in oil at this point even with Vladimir Putin’s involvement in Middle East. The risk profile for oil prices is changing. With U.S. influence and interest waning in the Middle East, the Saudis have been more engaged with the Russians about a defense agreement. With the interest of the Saudis and Russians aligned for higher oil prices it would not be surprising to see both on oil agreement and a defense agreement.
The Russians, Iranians, and Syrians are now all on one side of the camp. The Saudis are very concerned that the Iranian-funded Houthi rebels in Yemen will destroy Saudis oilfields. There are rumors of Russian brokered deals between Iran and Saudis where the Saudis reduce oil production in exchange for Iran no longer backing the Houthis. I think the Saudis willingness to over-pump is going to change when the threat to their oil fields recedes. What seems to be happing is a realignment of the petro dollar system.
As the date of this commentary (January 28, 2016) the West Texas Intermediate is trading around $32 a barrel but may move to $40 as the Middle East begins the realignment of the petrodollar system. The Chinese are already negotiating contracts and Letter of Credits with both the Saudis and Russian companies to pay for oil in Yuan, not dollars, and will have more and more influence. Two ways of playing the oil market is to buy an ETF such as “VDE” oil index fund or very high-cost oil producers, because of the margin, they’ll have the biggest impact.
There is nothing less loved then gold and natural gas. There may be more reasons to hate natural gas than gold. China will continue to cut rates and spend. And in Europe, one of the things that will increase interest in gold is negative rates. European government will most likely follow Japan and will issue long-dated bonds at negative rates, and will sell the idea based on the use of capital to build infrastructure, for example. With negative rates in Japan already it would not be surprising to see 141 Yen to the Dollar.
European unity is highly dependent on open border and on the free flow of capital and border. Europe needs young people to move in as their demographics become older and lead to economic contraction. With Germany’s open door policy leading to the potential outage of Chancellor Angela Merkel may end the free flow of open door policy. It is really crucial for Europe pulling together but that is not happening as Britain wants tighter control already for its borders. As Mario Draghi looking for a lower Euro it is not inconceivable that the Euro goes in parity with the U.S. dollar by end of the year further pressuring oil prices.
Our outlook for global stocks and bonds are very guarded given the high equity valuations and the low-interest-rate environment. The return outlook for bonds remains positive but muted. Our outlook for federal funds rate remains around 2.5% and as a result our estimate for the 10-year U.S. Treasury is 2.5% even with a rising-rate environment for 2016. The excess valuation in certain past high-performing sectors has been tempered by the general relative underperformance in 2015 putting our medium term outlook for global stock is in the 6% to 8% range.