TT's Ideas Factory propose several potential investment surprises for the year ahead.
As is customary in December, many of our fund management competitors and most of the broking community write outlook pieces for the coming year. Whilst these certainly have merit and are interesting to the reader, we are, as ever, keen to avoid following the herd. Instead, TT's ‘Ideas Factory’ – a combination of all our investment teams – has compiled our potential investment surprises for 2016. These are a collection of standalone ideas that could have important ramifications for markets if they were to come to pass. Readers should be clear that these most certainly are NOT our base case expectations. In some instances they are light-hearted speculation, and in others they are more serious possibilities worthy of greater consideration during portfolio construction. In all cases, we believe that they are not priced in, and have the ability to influence markets substantially in the year ahead. We hope that you enjoy reading them.
Of sheikhs and shale
Just as few foresaw the sharp sell-off in oil in 2014, virtually every commentator is surprised to see oil stage a substantial rally in 2016. Amid growing disaffection over the war in Yemen, the mismanagement of Mecca, and dwindling oil revenues, King Salman of Saudi Arabia is ousted. With a new regime in place at OPEC’s most important member, and the oil cartel earning only half the $1tn it was raking in each year before the price crash, OPEC decides to cut production to boost the oil price. This comes at a time when dramatically lower upstream investment is starting to curb non-OPEC production. As non-OPEC output falls and the world grows increasingly reliant on middle-eastern producers, concerns begin to grow about energy security as the region continues to be a maelstrom of sectarian conflict. There are also fears of production disruption in west Africa, Venezuela and to a lesser extent Russia, where dwindling budget revenues are leading to power struggles. As the price of oil rises, higher inflation leads to more hawkish monetary policy at the world’s central banks, which are now seen as being well behind the curve.
Clinton is Trumped
Despite insulting immigrants, women and the American electorate, Donald Trump pulls off a remarkable election victory to become US President. After winning every state that Romney won in 2012, the election comes down to Florida, where Trump is a part-time resident, and Ohio, where his “make America great again” message resonates with Reagan Democrats.Trump proceeds to cut taxes, injecting trillions into the economy and prompting the Federal Reserve to quicken the pace of interest rate hikes to prevent the economy from overheating. Meanwhile, a major crackdown on illegal immigration sparks a share price rally for those companies tasked with enforcing the new rules, including private prisons, security firms and defence contractors. Similarly, firearms manufacturers benefit as Trump lifts gun and magazine bans and introduces a national system so that gun permits are valid in all 50 states.
Following the Volkswagen emissions scandal and the Paris Climate Change Conference, the focus on renewable energy intensifies in 2016. Consequently, solar power and electric vehicles become more mainstream investment themes.
Picking the long term winners will be difficult – the key will be avoiding the losers. These are likely to include power generation businesses, oil companies and auto manufacturers that are ignoring electric vehicles. Indeed, the energy and transportation industries as we know them will be completely transformed over the next 15 years by exponentially improving technologies including solar, electric vehicles, and self-driving cars. Both the solar power and electric vehicle industries have been doubling about every two years and this is likely to continue due to improving technology cost curves and product innovation. Solar costs have been decreasing exponentially from almost $100/W in the 1970s to $1-$3/W today. On a cost/unit basis, solar has improved over 5,000 times versus oil and over 2,300 times against natural gas. Similarly, the cost of battery packs for electric vehicles has fallen from about $1,000/kWh in 2007 to around $450/kWh in 2014.
These same families have seen the value of their wealth collapse in international terms due to the rouble rout. They also suffer greatly because of sanctions imposed by the EU and the US following Putin’s aggression in Ukraine. Similarly, energy bosses rue the sanctions that have forced them to pump for their economic lives only for their products to fall into the hands of China as the marginal buyer of Russian oil and gas at bargain prices on long contracts. Many powerful business leaders crave stronger ties with Europe to facilitate more lucrative business deals, particularly with Germany, which is always keen to look east as well as west. As discontent grows, Putin is overthrown and the new Russian leadership applies to join the EU and the euro.
Source: Credit Suisse
The Fed raises rates in December and, in a classic case of ‘travel and arrive’, the dollar proceeds to weaken. This comes as a great surprise to commentators, most of which had expected dollar strength given US tightening in the face of easier monetary policy in the world’s second, third and fourth largest economies.
Emerging Markets promptly stage a relief rally from extremely depressed levels and are the best performing equity markets of 2016. Indeed, the evidence suggests that Emerging Market relative performance is far better correlated with the direction of the dollar than US interest rates. Indonesian stocks perform particularly well as inflation continues to fall and the current account position keeps improving. Consensus underweight Brazil, another of the ‘Fragile Five’, also rallies impressively, particularly after President Rousseff is impeached for doctoring government accounts.
Britain heads to the polls in autumn 2016 to decide whether it should remain in the EU. With net migration into the UK at a record high and security concerns about Syrian migrants, immigration is the electorate’s biggest concern. A well-financed Out campaign, supported by several influential newspapers, succeeds in persuading voters that the referendum is not really about the EU but rather about whether they want more or less immigration. Though Cameron manages to secure concessions from the EU limiting the benefits that migrants can receive, this falls short of voters’ expectations and Britain decides to leave the EU. Having campaigned to stay in, Cameron’s position as prime minister becomes untenable and he stands down. The Scottish Nationalists quickly capitalise on the situation by pressing for another referendum on Scottish independence. Negotiations to secure a special deal for Britain to retain free trade with the EU prove extremely difficult in the bitter post-Brexit atmosphere. Bond yields edge higher and sterling weakens.
A-share of optimism
The Chinese economy stabilises as monetary and fiscal easing take effect. Against this backdrop, a combination of growing investor confidence and savings pool reallocations push the A-share market to all-time highs. This allows China’s beleaguered banks to recapitalise themselves, tempting international investors back into Chinese Financials. Buoyant share prices also lead to a wave of mergers in the Banking sector, which enables balance sheet restructuring and draws in yet more foreign investors. With renewed capital inflows into China, the yuan strengthens, particularly as its newfound reserve currency status means central banks and institutional investors begin to accumulate yuan-denominated assets en masse. The stock market rally also bolsters household balance sheets, helping to generate double-digit gaming revenue growth in Macau.
The phrase “you reap what you sow” epitomises Europe in 2016. On the one hand, countries that planted the seeds of structural reform enjoy the fruits of their labour. Spain and Ireland, where reforms and restructuring have been most pronounced, see particularly strong recoveries. In sharp contrast, countries that failed to implement reforms with the same vigour see a poor harvest, posting disappointing growth. This is true of Italy, France and Greece. Low growth undermines efforts to reduce stubbornly high fiscal deficits, as does the increasing support for anti-austerity political parties. Subsequently, pressure mounts on Europe’s laggards, particularly Greece, where the Troika targets are missed substantially and ‘Grexit’ talk resurfaces.
Nothing in this document constitutes or should be treated as investment advice or an offer to buy or sell any security or other investment. TT is authorised and regulated in the United Kingdom by the Financial Conduct Authority (FCA).