The key question about the U.S. economy entering 2016 is whether China and other emerging economies will export their woes to the U.S. It’s a reasonable question because they generate a larger percent of global gross domestic product (GDP) than ever before.
But first, a review of 2015.
By the second quarter of 2015, it seemed clear the U.S. stock market’s higher-than-average valuations left it vulnerable to a correction.
Lofty valuations don’t generally trigger a selloff by themselves—they often need a catalyst, like, say, China abruptly devaluing its currency. That’s exactly what happened in August.
In response to a steep decline in its own economy, China’s policy makers moved to shore up its capital markets and stimulate exports by devaluing its currency.
Around the world, stock markets slid. When analysts see nations devalue their currency, they consider the tactic “hitting the panic button” because it is usually a last-resort attempt to rescue a declining economy.
Other emerging economies were also under considerable pressure at the time.
But was China really hitting the panic button? It’s difficult to know. Most of this nation’s economy is opaque to outsiders.
At the time, however, it was reasonable to suspect the world’s second-largest economy was under duress.
As a result, nearly half the S&P 500 stocks entered bear market territory. The steady gains for the year were mostly erased, and longer-term returns took a hit.
Investors’ aversion to risk also triggered a selloff in high-yield bonds while a flight to safety drove market interest rates generally lower. And emerging-market stocks, which had already been dramatically underperforming all year, fell even further.
The good news is, these setbacks appear to have been part of a normal correction rather than something more significant. We did not see the usual underpinnings of an extended bear market, such as an obvious collapse in economic growth, aggressive tightening of monetary policy, big inflation, or even an inverted interest rate yield curve.
By the end of October, U.S. markets had recovered most of their losses. Even so, the Federal Reserve felt sufficiently concerned about global conditions to hold off on widely anticipated short-term interest rate hikes.
The 2016 economic outlook
The Fed’s September 2015 Beige Book indicated continued modest growth over the previous month, similar to what we’ve seen since 2009. Despite negligible signs of an impending recession, this economy still has soft spots, most notably in the energy and manufacturing sectors.
Blame falling oil prices and a strong U.S. dollar, respectively, for that.
On the opposite end of the spectrum, the labor market and consumer spending are strong and gaining momentum. The unemployment rate dropped to 5% in October 2015, and real wages could finally increase as labor markets tighten.
The key question about the U.S. economy entering 2016 is whether China and other emerging economies will export their woes to the U.S. It’s a reasonable question because they generate a larger percent of global GDP than ever before.
Also, it’s highly likely the Fed will raise short-term rates for the first time in many years in December. We think the economy can easily absorb small increases over an extended period, but anything other than that could be a problem.
How to prepare for 2016
Although the outlook is for continued economic growth, we saw in 2015 how difficult it has been for the Fed to rise above a 0% federal funds target rate. So, modest expectations for improvements in net interest margins are warranted.
Reasonable creativity will likely still be required if credit unions are to achieve their balance sheet investment goals.
Returns for other investments funding your credit union’s 401(k), pension, etc., will likely be more volatile than they have been in many years.
Likely divergences mean you’ll need to look under the hood of your credit union’s investment portfolios to fully understand your returns. In that regard, your investment consultant can help you understand how your investment engine in actually running.