As we approach the end of 2016, we’re increasingly of the view that we’re nearing the end of one investment era and the beginning of another. We expect this global trend to be positive for China, but it might have a downside for some risk assets.
There are signs, though only tentative, that the global investment and policy landscape in fourth-quarter 2015 could lead to a reversal of what, three years ago, were three key market-shaping events. Then, markets were in an expanding “balance sheet world,” in which central banks were pumping more liquidity into the global financial system to keep economies afloat.
In September 2012, the US Federal Reserve launched its third round of quantitative easing (QE); in December of that year, Shinzo Abe became prime minister of Japan for the second time and, two months later, launched his Abenomics reforms in an attempt to boost the country’s growth and inflation.
The central banks hoped that, by helping to lift asset prices, they would reignite the “animal spirits” in their economies. An important consequence of these actions was that financial markets—particularly risk assets—became disconnected from the macro environment, as liquidity drove valuations higher than economic fundamentals warranted.
At the same time, there was a countercurrent to these events. In November 2012, Xi Jinping became president of China and—as part of a suite of reforms aimed at rebalancing the country’s economy—launched a crackdown on corruption.
As the US and Japan attempted to stimulate growth, Xi’s actions had a dampening effect, leading to a slowdown in infrastructure and other projects in China. This in turn effectively put an end to the global commodities boom and created economic headwinds for commodity-exporting countries.
Policymakers Change Course
As of November 2015, the authorities behind each of these three policy initiatives appear to be changing course. Having put an end to quantitative easing a year ago, the Fed—though weighing an improved US economy against global market volatility—is expected to raise short-term interest rates for the first time in nine years.
The policy debate in Japan now revolves around whether or not the Bank of Japan (BoJ) should ease further, with the BoJ governor arguing against it on the grounds that the country is through the worst of its deflationary spiral. If he’s right, we believe Japan could signal a tapering in its QE program next year. This is an out-of-consensus view, as the market is still looking for an extension or top-up of the program.
China’s 13th Five-Year Plan, an outline of which was announced after the October Communist Party plenum, focuses on reforms that will continue to push the economy up the value chain, making it more efficient and innovative, with the aim of reducing the risk of the country falling into the middle-income trap.
The country, in other words, still seems to be moving in the opposite direction from that of the US and Japan in terms of policy. This time, however, it’s more pro-growth, while the US and Japan are contemplating moving to tighter policy settings.
Macro Factors Back in Play
Together, these trends point to a rebalancing in global markets in 2016. With the US poised to raise interest rates, Japan potentially tapering its QE and China experiencing a mild cyclical upswing, macroeconomic factors are likely to reassert themselves as key investment drivers, in our view.
What does this mean for investors? It’s yet another reminder to avoid “crowded trades,” particularly those created by investor responses to central bank balance sheet building over the past few years, or the slowdown in China. It also suggests that the ability to move dynamically into and out of sectors, geographies and markets is even more important now. And active management—stock and security selection in particular—is especially critical.
In our next blog, we’ll look more closely at the implications for China.
(c) Alliance Bernstein