CIO Insights: 2016 Outlook – Continuing Our Four Themes, in a Stronger U.S. Dollar Environment

With most market attention focused specifically on Federal Reserve (Fed) interest rate policy and China’s growth, we still believe four broad themes we’ve highlighted consistently during the past 15 months will govern the global markets in 2016: 1) divergence, between the U.S. and the rest of the world in economic growth and central bank policies; 2) normalization, with more risk and higher interest rates as the Fed withdraws monetary stimulus; 3) volatility, as markets normalize, and 4) opportunities for active managers to add value with security selection. We believe these conditions favor the U.S. dollar and earnings derived mainly from U.S. sources.

Read the full Q1 2016 CIO Insights Intro:
2016 Outlook – Continuing Our Four Themes, in a Stronger U.S. Dollar Environment

The global economy and capital markets hit big bumps in 2015 that will likely be felt well into 2016. Europe surged initially, then faltered; Japan slid in and out of recession; China’s growth decelerated, leading to devaluation of the yuan; Greece and Puerto Rico defaulted; commodity prices plunged; and manufacturing floundered. Conditions looked particularly bleak in the third quarter when more risk-oriented markets (stocks, high-yield bonds, emerging market debt) suffered sell-offs as investors sought safer harbors for their assets.

As we approach 2016, conditions feel calmer than in the third quarter, helped again by the panacea that pushed us past the 2008 Financial Crisis and Great Recession: aggressive central bank monetary policies, particularly in China, Japan, and Europe. Big questions remain about global economic growth, but the markets have been soothed somewhat by more massive monetary intervention. China spooked the markets in August, but we don’t believe it will trigger a global recession.

Conditions, particularly in the U.S. and in the service economy, appear stable enough for the Fed to begin normalizing interest rates from their extremely low levels (see the graph below). Pace is important: We believe normalization should occur in small steps in an environment where global inflation and economic growth—especially in commodities and manufacturing—remain low and fragile, respectively. As U.S. interest rates rise, U.S. dollar appreciation—particularly against currencies based in emerging markets and economies still experiencing massive monetary easing—could become a significant global headwind.

In this environment, U.S. dollar-denominated assets and vehicles with predominantly U.S.-derived earnings appear favored. Our discipline CIOs highlight the potential 2016 themes and opportunities they see within their markets in their CIO Insights this quarter.

Generally, as interest rates rise, bond values will decline. The opposite is true when interest rates decline.

International investing involves special risks, such as political instability and currency fluctuations. 

The opinions expressed are those of G. David MacEwen and Victor Zhang and are no guarantee of the future performance of any American Century Investments portfolio.

For educational use only. This information is not intended to serve as investment advice.