Global Market Commentary

December 11, 2015

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Market Summary

As we survey the investment horizon for 2016 the picture that we see is not highly attractive.

Economic and Financial Fundamentals: Slightly Positive

On a fundamental basis, the world is growing at a modest rate, and the return to a big deflationary trend in North America, Europe, or developing Asia is becoming less likely.  We will see economic growth in line with 2015, or slightly better, in many parts of the world as 2016 develops.

Corporate profits, the mother’s milk of stock market appreciation, will grow at a modest rate and inflation will replace commodity-led deflation.  A combination of these variables will lead to corporate profit growth of 3 to 5 percent in the U.S., and slightly better than that in Europe and Japan.  The latter two will benefit from their currencies’ depreciation against the U.S. Dollar.

Short term interest rates will rise from the current 0.25 percent level, and long-term rates should rise more slowly from their current 2.97 percent level.  Currently we anticipate that the short-term rates could exceed 1 percent by the end of 2016, with long-term rates up slightly.  This will provide a less steep yield curve, but one that’s still far from the inverted yield curve which historically leads to a recession.

Current Stock Market Valuations: Slightly Above Normal in the U.S., and in the Normal Range For China, Europe, and Japan

U.S. stocks are not cheap. In much of the world, they are fairly valued, but they are slightly overvalued in the U.S.

We do not see great opportunity in stocks in the U.S. unless we have a market correction which brings stocks back into the normal range, or unless corporate profits grow at a rate much faster than 5 percent. The likelihood of U.S. corporate earnings growing well above 5 percent is small as long as the U.S. Dollar keeps rising versus the currencies of our trading partners. Should the Dollar reverse its current appreciation, we could see rapid growth in US earnings and thus in stock prices.

In 2016, the two most important variables are U.S. Dollar valuation against the currencies of trading partners and the current price of the U.S. stock market indices.  The best of all worlds would be a decline in the Dollar and a correction in U.S. stocks which would create a buying opportunity.

          Europe and Asia

The decline in the value of these countries’ currencies will grow their export opportunities and they may experience earnings slightly better than 2015’s.  Growth will still be modest and opportunity for profitable stock purchases in these regions will depend upon market valuations.  Currently, valuations are fair and good companies can grow and appreciate in value.  Stock selection must be based upon strong tailwinds and growth prospects for individual companies.

If the Dollar begins to fall, corporate profits in the U.S. will improve and corporate profits in Asia and Europe will deteriorate.  When commodities settle down and create a bottom, possibly as early as the second half of 2016, commodity-producing countries like Canada and Australia will become more attractive for investment.

          Oil, Gold and Commodities

Gold, oil, and commodities are correlated inversely to the U.S. Dollar. When the Dollar stops its increase, these commodities will rally.  There are two influences that will impact commodities in 2016: the Dollar and the inflation rate.

We do not believe that large demand increases will be forthcoming in 2016, so any appreciation in gold or oil will be due to inflationary influences within the developed world.  We foresee modest increases in inflation and interest rates.

In summary, without a turn in the rising value of the U.S. Dollar, we see only modest appreciation or sideways price action in gold and oil.

Investment implications:  We will see economic growth in line with 2015, or slightly better, in many parts of the world as 2016 develops.   Corporate profits will grow at a modest rate and inflation will replace commodity-led disinflation.  Short term interest rates will rise from the current 0.25 percent level, and long-term rates should rise more slowly from their current 2.97 percent level.

In much of the world, stocks are fairly valued, and they are slightly overvalued in the U.S.  We do not see great opportunity in stocks in the U.S. unless we have a market correction which brings stocks back into the normal range.  Should the Dollar reverse its current appreciation, we could see rapid growth in U.S. earnings and thus in stock prices.  In 2016, the two most important variables are U.S. Dollar valuation and the current price of the U.S. stock market indices.  The best of all worlds would be a decline in the Dollar and a correction in U.S. stocks which would create a buying opportunity.

Growth will still be modest in Europe and Asia, and opportunity for profitable stock purchases in these regions will depend upon market valuations.  If the Dollar begins to fall, opportunities for investment in the U.S. will improve and opportunities for investment in Asia and Europe will deteriorate.  When commodities settle down and create a bottom, possibly as early as the second half of 2016, commodity-producing countries like Canada and Australia will become more attractive for investment.  Gold, oil, and commodities are correlated inversely to the U.S. Dollar. When the Dollar stops its increase, these commodities will rally.  Without a turn in the rising value of the U.S. Dollar, we see only modest appreciation or sideways price action in gold and oil.

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