This is my 31st year giving my views on a number of economic, financial market and political surprises for the coming year. I define a “surprise” as an event that the average investor would only assign a one out of three chance of taking place but which I believe is “probable,” having a better than 50 percent likelihood of happening.
Here is my list of ten surprises for 2016:
1. Riding on the coattails of Hillary Clinton, the winner of the presidential race against Ted Cruz, the Democrats gain control of the Senate in November. The extreme positions of the Republican presidential candidate on key issues are cited as factors contributing to this outcome. Turnout is below expectations for both political parties.
2. The United States equity market has a down year. Stocks suffer from weak earnings, margin pressure (higher wages and no pricing power) and a price-earnings ratio contraction. Investors keeping large cash balances because of global instability is another reason for the disappointing performance.
3. After the December rate increase, the Federal Reserve raises short-term interest rates by 25 basis points only once during 2016 in spite of having indicated on December 16 that they would do more. A weak economy, poor corporate performance and struggling emerging markets are behind the cautious policy. Reversing course and actually reducing rates is actively considered later in the year. Real gross domestic product in the U.S. is below 2 percent for 2016.
4. The weak American economy and the soft equity market cause overseas investors to reduce their holdings of American stocks. An uncertain policy agenda as a result of a heated presidential campaign further confuses the outlook. The dollar declines to 1.20 against the euro.
5. China barely avoids a hard landing and its soft economy fails to produce enough new jobs to satisfy its young people. Chinese banks get in trouble because of non-performing loans. Debt to GDP is now 250 percent. Growth drops below 5 percent even though retail and auto sales are good and industrial production is up. The yuan is adjusted to seven against the dollar to stimulate exports.