Don’t give up on stocks

I know it sounds like a crazily constructed concept — more of the same but better — however, these are crazy times so what I’m saying is that you should expect stock market volatility, questions about China, doubts over the health of the global economy, the interest rate rises in the US and geopolitical concerns as well as doubts about Australia’s economic recovery, but in the end the results will be better!

If you think in graphical terms then visualise our economic growth and our stock market rising on a steeper trend. That’s the simple summary for next year so let me justify this view by looking back on 2015 for lessons that will help explain my position.

Let’s start at the most vital point for anyone wanting to build wealth in 2016 — the economy. I often argue with Roger Montgomery on this subject but it is certain if the world believed Australia and the global economy were heading for a recession then stocks would be falling a lot harder than they have been in the scary stock market weeks of 2015.

Commodity prices and the fear of the Fed has taken our S&P/ASX 200 index down below 5000 but that’s when I told my followers it was the time to buy because the overall economic outlook for 2016 is not bad, mad or horrible. The economic outlook is mixed and debatable but it’s not seriously worrying and could easily prove to be miles better than the consensus view.

On the Australian economy, I’m definitely in the “we’ll be right” camp and the economic story as we wound down 2015 confirmed that my economic optimism over the year was spot on.

I also believe the run of economic data sets us up for a solid start to 2016, which will only improve with most economists tipping the second-half will be stronger than the first half!

In case you missed the good economic news as we launched into the silly season, which nowadays starts after the Melbourne Cup, here it is:

• Unemployment has gone from 6.2% to 5.8%;
• Employment has increased by about 145,000 in the three months September to November, that’s the biggest back-to-back jobs gain in 28 years;
• The participation rate rose from 65 to 65.3 in November, which makes the unemployment result even better to behold;
• Business confidence, according to National Australia Bank, has gone from 1 in August to 5 in November;
• The Westpac consumer sentiment reading has gone from 93.9 in September, where pessimists outnumbered optimists, to 100.8, where optimists now beat pessimists, with 100 being the dividing point between the two groups;
• Economic growth for the September quarter came in at 0.9%, after a low 0.3% in July. This was the fastest economic expansion in 18 months;
• Car sales are at a record high;
• There are record Chinese tourists coming to Australia;
• We’ve had the fastest growth in business credit in six and a half years;
• Company profits rising for the first time in five quarters;
• Even department store sales soared by 3.5% in October as retail rose 0.5%, which means it’s up 3.9% over the year; and
• My favourite is a forward indicator of employer intentions to create positions in their workplaces, which rose by 1.3% in November. These ads in newspapers and online have risen 16 out of 18 months and are up 12.3% over the year! On a trend basis, they’ve risen 25 months in a row!

As you can see there are plenty of reasons to believe that our economy is moving into a higher growth path in 2016. This should underpin a rise in earnings for many companies that are leveraged to a stronger economy.

Until now, I’ve left out the impact of a change of leadership in Canberra which to date has not only coincided with a huge lift in the political stocks for the Coalition Government, it has also, seemingly underpinned a spike in both business and consumer confidence, which I hope the new team in Canberra can sustain.

I have warned my former economics student at the University of New South Wales — Scott Morrison — and my former patrol member at North Bondi Surf Club — Malcolm Turnbull — that they have to be careful about talking too much about the GST and taxes on super, when their main job for next year is to get economic growth up over 3%. When we grow faster than that pace unemployment falls and that’s critical to creating a confident consumer and business investor/job creator.

One of the great mistakes of the Abbott Government was to talk too much about debt and deficits instead of getting growth up and going. Faster growing economies bring in tax and lower deficits, so this is the job for next year.

Note in year two of the Abbott Government, the former PM and Treasurer Joe Hockey turned their attention to growth and their second Budget brought the small business tax write-off that instantly boosted business confidence.

There were many critics of the measure but by mid-December, Treasury revealed 99,000 small businesses had claimed the tax break between July 1 and December 15 and this added up to $418 million! Who thinks governments can’t stimulate growth?

Okay, on our own, the Australian economy looks set to deliver on my optimism but what about the global economy?

GLOBAL CHALLENGES

The demand of the world economy is one part of our commodities prices problem while the other is the oversupply of oil, iron ore, etc., which explains why prices have been sliding.

Ironically, when the global demand starts to pick up the relevant suppliers, such as OPEC (Organisation of the Petroleum Exporting Countries) would be more likely to restrict output on the basis that the world economy can actually cope with higher prices.

While lower oil prices might be hurting energy company stock prices and related companies, they also are giving the global economy a massive tax cut and business cost cut that should actually be a plus for economic activity. It might be in 2016 that the pluses from the lower oil prices start to outweigh the stock market negativity from the same falls in commodity prices.

I don’t like tipping commodities but I suspect we are around the bottom and so I’m not expecting big falls in prices like we have seen over the past year.

Stocks connected to commodities might still have a tough year ahead but the worst could be over and even if prices fell some more they should be smaller falls.

There could also be a currency development next year that could help commodity prices and stocks. The chief economist at Morgans, Michael Knox, thinks commodities will improve over 2016 as the greenback eases and the euro starts to pick up. Using what he calls standard deviation analysis, which most normal people scratch their head over, he says it tells him that the euro’s slide is close to its endplay. When this happens it U-turns against the US dollar, which helps commodity prices rise purely on a lower valued greenback. Now let’s see what the international economy picture looks like.

With those US job numbers and with the Fed having raised rates because the US looks good, this economy should be crucial to the global economic picture. I think the US economy will keep growing close to trend and should not let optimists down in 2016.

This is what the European Commission said on November 5: “The economic recovery in the euro area and the European Union as a whole is now in its third year. It should continue at a modest pace next year, despite more challenging conditions in the global economy.” I also believe Mario Draghi only did less than what the market expected because he has a more positive view on the outlook for the Eurozone than the market experts.

China is a bit of a worry, with the Organisation for Economic Co-operation and Development (OECD) now expecting the global economy to grow 3.3% next year, downgraded from 3.6% in its September forecast, and China’s slow down was seen as a big cause. Growth in China is now projected at 6.5% in 2016 and 6.2% the following year, as its economy faces sluggish manufacturing investment amid excess capacity.

I think Beijing will respond with stimulus measures. I also think that we watch manufacturing too much, which is becoming less important as the Chinese economy transforms into a greater services economy.

“The October trade data keeps pressure on for more domestic easing,” said Louis Kuijs, head of Asia economics at Oxford Economics in Hong Kong. “Measures are likely to continue to focus on shoring up domestic demand rather than weakening the currency. And over time the role of fiscal policy expansion should rise.”

I won’t underestimate what China might do to push up growth, which will help our economy as well. By the way, Chinese doubters had to deal with the November retail sales, which were up 11.2% — the fastest in 11 months.
Japan has had some problems, with the economy going into a recession for the second time in 18 months!

However, this is what Focus Economics observed: “Nevertheless, there were some positive developments, including a strong recovery in exports and private consumption that, if sustained, has the potential to boost growth in Q4. In an attempt to shore up economic activity, the government is considering a supplementary budget for this fiscal year in the range of JPY 3.0 trillion to JPY 3.5 trillion (USD 24 billion to 29 billion).
The plan could include funds to support the agricultural sector and boost social spending.”

For the overall global economy, you have to realize that a big chunk of it — Japan and the Eurozone — are into quantitative easing. Given that QE works slowly or with a lag and given that more stimulus is likely for China and any other economy still struggling to get growth higher, then I bet the world economy picks up over 2016.

And here’s a good omen. Remember the basket case economy called Ireland? Well the Financial Times recently ran with a story suggesting that the ‘Celtic Tiger’ is growing at 6% and one UK fund manager who went long on Ireland a year ago, says it will be closer to 7%.

I’m punting on a few more economic surprises next year.

SO WHERE DOES THIS LEAVE STOCK MARKETS FOR 2016

The simple answer is that we are in a bull market, which has been described by the likes of the former chief equity strategist at Macquarie Bank, Tanya Branwhite (who now has been seduced to the Future Fund) that we’re in a long, grinding higher bull market. This effectively parallels the economy that’s also slowly grinding higher.

Historically, we have tracked Wall Street. I think this follow-the -leader trend will continue but I’d bet that the S&P/ASX 200 index will rise faster than the S&P 500 on Wall Street.

Our index has gone from 3145.5 to around the 5,200 level, which is a 65% gain. Meanwhile the S&P 500 has gone from 676.53 to around 2100, which is a 210% gain!

The Yanks have kicked butt, as the chart below shows!

Our stocks are overdue for a surge!

We’re due for a massive catch up. It could be driven by a better local economy (which I expect), a weakening (yet still strong) greenback, which will help commodity prices and stocks such as BHP and Rio. On top of this currency help for commodity stocks, a stronger world economy should also improve the outlook for stocks down under.

And for those who like historical omens, the year of a US presidential election is good for stocks. In fact, the year before is generally better but I think some of the good stuff from this year will roll into 2016.

Looking for more support for my stocks’ optimism? Let me share what I discovered as I trained it to London to Paris (and what a great service is the Eurostar!) I read a nice piece in the Financial Times that I might’ve missed if I was at home. It was penned by Mike O’Brien, co-head of solutions at JPMorgan Asset Management.

Let me sum up his main points, while decoding some of his high-brow, market-speak that mere mortals will be bored by or could sleep by! So here goes:

• Believe it or not but “the scales are tipping in favour of investors willing to take more risk”, as the returns on safe assets remain low and other assets promise higher returns. (This is a case for going long stocks, despite what we’re enduring right now.);
• He’s not tipping a huge change in 2016 but he is expecting slightly better times. His team forecasts continued low inflation, subdued economic growth, with the globe’s real economic growth at 1.75%;
• Developed economies will reduce their deleveraging tendencies, which has depressed growth;
• Return expectations for the balanced investor have increased, it is argued, and a 6% return is predicted over the next 10-15 years. (If we throw in our franking credit bonus in Australia, then we’re more likely to be in the 7% or so neighbourhood.);
• He expects returns on fixed income assets to remain subdued, depressed — you choose the word — but it means we all have to take on risk to pump up returns;
• High yield debt will be good and so corporate bonds and products of that ilk will be the way you ramp up fixed income returns;
• Developed market equities are tipped to be in the 6.75% region;
• Emerging economies are seen to offer about 9.75%. (I’d warn to be careful which one you punt on. Maybe an ETF that groups these economies could be a speculative play.); and
• O’Brien thinks hedge fund managers and active managers will beat passive returns. (But people from financial institutions often argue that because they either believe it or they’re talking their own books.),

His conclusion is important and this is it: “Return expectations for riskier assets are improving as those for ‘safe’ assets worsen.”

His bottom line, despite all the market madness right now, is “investors with a stomach for volatility” should be “increasing their holdings of equities, credit and alternative assets.”

So, what’s my main point I’d like to share with you about 2016? I wrote this on December 14 before the spike in markets the next day:

“These market slides we’re seeing now are a buying opportunity for long-term investors. Buy quality companies that pay dividends, which puts me at odds with O’Brien but many have been beaten up too much lately. Maybe try an ETF (exchange-traded fund) that gives you exposure to smaller cap companies, which is consistent with O’Brien’s suggestions.”

One final nice omen was the over-200 point reaction on the Dow Jones index after the Fed raised the official interest rate by 25 basis points. This was not only a win for good sense, it was showing that the consensus that ultimately drives stock markets — not short-term speculators — believes that the US economy and its companies are heading in the right direction.

The bottom line is: don’t give up on stocks!

This is my war cry for 2016. If I change my mind on this subject, you’ll be the first to know!