Five risks that will shape events in 2016

July 20, 2016

The year had a turbulent start with plummeting oil prices and slowing economic growth in China unsettling world markets in January.

We expect the global economy to “muddle through” with global sharemarkets likely to generate decent, if unspectacular, returns this year.  Still, there’s no room for complacency.

Mercer’s global investments research team expects the developed world recovery to remain broadly on track in 20161. But a global recession, although unlikely, remains an important risk for investors to consider.

The year ahead promises many more sources of uncertainty, both economic and political, including the pace and impact of China’s deceleration, heightened geopolitical risks around the globe and increasingly nationalist politics in Europe and the US, to name a few.

The extent to which such risks will actually impact economies and markets cannot be known – nobody has a crystal ball – but we continue to plan for the event that they will have an impact.

Here are five key risks we think will shape events in 20162.

 

Economic and market outlook 2016 and beyond

Phil Edwards (European Director of Strategic Research) and Rupert Watson (European Head of Asset Allocation) discuss Mercer’s outlook for the global economy and markets against the backdrop of a volatile start to the year.

 

1. An aggressive US Fed

The US Fed raised interest rates in late December, for the first time in 10 years and many investors are taking the move as a sign of confidence in the American economy. We can expect more hikes in 2016 and beyond; whether or not this has a negative impact on global markets depends on the speed and magnitude of further interest rate increases.

The market and most investors expect the Fed to raise interest rates very slowly and if that’s the case – if rates remain at or below 1% by the end of 2016, for example – then the impact on bond and equity markets would probably be modest.

However, if rates were to go up more rapidly bond markets, and potentially equity markets, could suffer. Although we would expect any equity market falls to be temporary, bond market falls could be more permanent.

Interest rate increases are unlikely to have a significant impact on developed world economies but they could undermine some emerging market economies, especially if the US dollar rises sharply.

 

2. China and Emerging Market

Many of the world’s emerging market economies face significant structural challenges, from reforming the Chinese economy to adjusting to lower commodity prices. Overcoming these challenges is a bit like losing weight — easier in theory than in practice.

China remains a significant source of risk to the global economic outlook. The most likely outcome is a gradual slowing of the Chinese economy as it rebalances towards domestic consumption. But the slowdown in China has also heightened risks in other emerging market economies, highly dependent on Chinese demand.

Progress has been made in improving competitiveness in some emerging market countries, but at the cost of high unemployment and very weak economic growth. This weak economic growth, though necessary, increases the risk of a financial accident such as sovereign or major corporate defaults.

Brazil looks especially fragile given its domestic political problems, and an accident in one economy could have repercussions for financial conditions across the developing world.

However, we do expect emerging market economies to stabilise this year without a major crisis.

 

3. Terrorism and geopolitical shocks

Terrorism and geopolitical risks also loom more generally over the global economy and markets. The Paris attacks in November last year and a more general increase in geopolitical risk have had little impact on economies and markets so far.

However, these risks are perhaps higher than they have been for some time and have the potential to undermine economies and markets.

Being aware of the risks and having portfolios robust enough to withstand major shocks is important, even if, in practice, knowing the likelihood or severity of any event is impossible.

 

4. European fragmentation

Though the economic environment in the eurozone is much improved, with government deficits much closer to be being under control, the political environment remains fragile following a prolonged period of high unemployment in many countries.

The popularity of mainstream political parties has fallen sharply, while the refugee crisis is creating additional political pressures within the region.

This year, the UK is likely to hold a referendum on whether to remain in the European Union (EU) — the so-called “Brexit”. Opinion polls suggest the vote will be close. Predicting the impact of the build up to the vote and the response to the result is difficult, but it seems likely the uncertainty will hit business confidence, leading to a modest, temporary hit to the economy.

 

5. Pick up in productivity

Finally, and on a more optimistic note, we may see a pick-up in productivity in the US, the UK and other developed economies. Productivity growth has been very weak over the past few years, but we have seen signs that it has, at last, started to improve.

If this trend were to continue, it would provide a boost to corporate profits and reduce the risk that the US Fed and other central banks would have to raise interest rates more aggressively.

 

1. Mercer, 2016 Themes and Opportunities for Investors
2. Mercer, Economic and Market Outlook 2016 and beyond

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