2015 was a year of “two faces”. Until August, the European stock exchanges ran with double-digit performances, in the second half of the year the gains were reduced. All in all, looking back on the scenario at the beginning of 2015, there were no major surprises, some risks actually materialised, while other risks remain decidedly current.
In fact, 2016 began under the banner of volatility, with the Chinese stock market which is sinking stock markets all over the world and the World Bank which, once again, is forced to revise its global growth estimates downwards.
Projecting us to 2016, I ordered the main risk factors in one graph: on the abscissa axis is placed la chance (evaluated qualitatively) that the single event occurs, while on the ordinate axis it is theimpact it could have on global financial markets.
Our approach does not attribute absolute probabilities but relates single events to themselves: in other words, the graph (click on the image to enlarge) represents what we believe is more likely and more impactful on the markets compared to all the risks mentioned. Let's see them.
The Fed fails to contain market volatility
After 5 years of aggressive monetary policy, the Fed is the first central bank to embark on a long process of normalizing interest rates. When rates go up, bond prices go down, but if the increase is gradual (considering low inflation and the level of overall growth in the economy there's no reason to believe it shouldn't be gradual), markets adjust without too many jolts. However, if the Fed fails to keep investors' expectations under control, the rate hike could be more violent and have repercussions on international bond markets and therefore on investors' portfolios.
The increase in the price of oil to 100 dollars
The collapse in oil prices last year is mainly due to the decision of OPEC to increase crude oil production in a context of low demand. If for some reason crude oil production were to collapse (either by OPEC decision or by external factors) in the face of an increase in demand in 2016, the opposite effect could occur: an increase in the price of oil. And, as Anatole Kaletsky recently wrote, a sharp rise in crude oil is followed by global recessions (whereas a drop in oil prices is mostly followed by an acceleration of economic growth).
Crisis of Emerging Countries
The appreciation of the US dollar, political instability and the collapse in commodity prices have put the economies and markets of emerging countries under pressure. According to the International Monetary Fund, in 2016 both Brazil and Russia will be in recession and the Chinese growth rate is destined to slow down further. In recent days, the Chinese market has come under pressure again (as happened several times in 2015) following the disappointing data on the PMI, forcing the authorities to intervene to stem the losses. To calm the markets we need comforting data on the macroeconomic front. Since 2/3 of world growth is attributable to Emerging Countries, any stronger than expected deceleration could undermine global growth and financial stability.
Escalation of geopolitical conflicts
The Paris attack called into question the internal security strategy and the foreign policy priorities of the entire European Union. The unresolved Libyan question, the fight against terrorism, the recent tensions between Russia and Turkey (NATO) and the eternal conflict between Israel and the Arab world (in particular Iran) are more acute risks than ever and there make it possible to ignore any repercussions on the financial markets, even if for the moment they seem limited. And now North Korea is also flexing its muscles.
The default of energy companies
In addition to Emerging Countries, the collapse in raw materials penalized the energy sector, which has a not negligible weight on both the equity indices and the Investment Grade and High Yield bond indices, as well as on employment and corporate investments. The default of some important issuer could generate panic, with possible knock-on effects.
Abenomics bet fails
Japanese institutions have been spending a couple of years on one of the most interesting economic "experiments" of the last 30 years: the so-called Abenomics. The cooperation between the central bank and the Japanese government has no equal in the rest of the world, yet both the level of inflation and that of economic growth remain well below the targets set by the institutions. With the highest public debt in the world (equal to 230% of GDP), structural reforms must bear fruit sooner or later, otherwise the country could risk losing the confidence of the markets.
Grexit, Brexit and economic/political fragility of the Eurozone
2015 ended with a substantial victory for the pro-euro parties. However, the anti-euro parties are looming: in France the Front National has not conquered any region, but has nevertheless confirmed itself as the leading party in the country. As long as the unemployment rate remains at politically unacceptable levels, downsizing the European project will always be on the table. Greece has slipped off the pages of the newspapers, but remains a fragile country, with a weak coalition government. Furthermore, the pro-Brexit campaign is intensifying, with a good grip on both public opinion and the British business class.
A good portion of the Conservative party is in favor of the United Kingdom leaving and if Prime Minister David Cameron fails to obtain some concessions on the advanced reforms he could force his hand and bring forward the referendum. The exit of the United Kingdom from the Union would be a serious blow to the whole European project. Despite bond yields at historic lows, the eurozone remains fragile and more sensitive than other developed countries to changes in market mood.
The risk scenario is far from rosy. Even if we remain moderately positive on risky assets, given our medium to long-term outlook, we expect 2016 to be somewhat volatile, as can be seen from the extreme volatility in the first market sessions.
