What To Expect In 2016 (And Beyond)

It is again time to put in print in one place some specific speculations on what may happen in the coming year. We do this with the intent of
getting investors to think about what could happen and factor that into their decisions on how to adjust their portfolios to take advantage of
opportunities while at the same time being aware of the risks. What I typically try to do is include those elements where I believe the odds
are high enough of an occurrence to have consideration when constructing a portfolio.

I must say it has been more difficult to come up with specific speculations around which I have some confidence. There appear to be more variables in play than normal with most residing outside the US. Within the US, at least through the first part of the year, we are likely to see a continuation of what has been experienced in 2015. I have been tempted to simply republish last years “What to Expect...” piece. There is real possibility of more of the same.

As we have pointed out in recent blogs we expect the dispersion in company performance and stock performance to continue against a backdrop of slow growth and continued difficulties in the energy and commodity patch. The investment opportunities will be very specific in both equities and fixed income. This will likely call for a reduction in risk in the core of a portfolio with the addition of managers who, historically, have done well in a more volatile environment. The opportunity set may look very different as we get toward the middle of 2016. Many of the expectations we spell out below will most likely unfold as we get later into the year. A single set of prognostications at the beginning of this year that prove to hold for the full year require more prescience than most of us can bring to the party—certainly this year. This will be a year in the public markets that will require nimbleness. The opportunity set away from the public markets may prove to be more attractive with less volatility.

Maybe this will become clearer as we move through some of our speculations for 2016. This year in particular, these expectations are designed to make one think about risk and some of the uncertainties we are facing as we move into 2016. I have tried to move beyond the momentum of what we have just been through in the markets to speculate on what could happen before the year is over. I have provided some specific observations in a Q&A format which will repeat some of what you may discover in the Expectations below. I would urge you to read the paragraphs before moving to the Q&A. The paragraphs tell more of a story. The Q&A has declarative statements, which must always be taken with a grain of salt, but are easier sound bites. Let us proceed.

UNITED STATES: THE ECONOMY CONTINUES TO GROW, BUT PERFORMANCE DISPERSION INCREASES AGAINST A BACKDROP OF PROFIT DISAPPOINTMENTS
In an economy that experiences real growth in the 2–3% range combined with low inflation, the differences in profit performance among companies become more stark. With activist money managers nipping at their heels, corporate boards push through an even higher level of management changes combined with a pickup in M&A activity spreading through a wider variety of companies. While we will see a few large combinations similar to Dow/DuPont, many of the corporate actions will involve spin-offs or targeted acquisitions of smaller 
companies without the capacity to grow their own businesses. Don’t look for significant premiums in these transactions. In contrast to past patterns, the value proposition may be in the buyer as opposed to the seller. Premiums may occur when the bidding comes from outside the US, e.g., China. Some of the consolidations will come out of credit issues primarily in the energy and commodities space. We do expect commodity and energy prices to stay low at least through the first half of 2016. Recognize that financial restructurings do not necessarily remove capacity from the market place. In fact, with reduced financial burdens, the ability and necessity to continue producing is increased.

While slow growth may produce credit issues beyond the energy and commodity sectors, they will be very specific. In general, the credit markets—both public and private—may offer some of the best investment opportunities for 2016. In both equities and credit, given the dispersion in results, active managers, in our view, will likely outperform the indices.

THE REST OF THE AMERICAS: STILL SOME ECONOMIC ISSUES BUT AN IMPROVING PICTURE AS ONE MOVES FROM NORTH TO SOUTH
Canada in many ways is a large natural resource company. Until the energy picture improves there remain issues as a new and different government starts to grapple with the current environment. In addition, while the Canadian banks avoided much of the turbulence experienced in the US from the mortgage fiascos, their housing market has gotten somewhat extended from growth that occurred under the umbrella of high energy prices in the early part of this decade.

On the other hand we see elements of reform and a better competitive environment globally in Mexico. Lower energy prices have slowed development and reform in this sector, but other sectors continue to move forward. This remains a good story of growth, reform and development.

Moving further south, if the project stays on schedule, by mid-year the expanded Panama Canal should be in operation with the ability to receive the Post-Panamax cargo ships that carry two to three times the previous loads that could make it through the canal. This will change patterns of traffic to the east and west coast ports of the US from East Asia, reduce transportation costs, and most likely produce a shift of traffic via the Suez Canal back to Panama. It could likely result in some increased infrastructure spending for some of the US ports as well as the supporting rail and truck traffic from these new patterns of shipping. An under-the-radar change that could have some unintended consequences positive and negative.

With the Argentina election leading to major change combined with elections in Venezuela and pressure on Brazil to change, the center of gravity on reform and a better investment environment in South America may be moving in the right direction. There is no question that the overall economic situation in South America is quite dependent on exports of hard and soft commodities. Until the commodity supply/demand picture improves, it may be difficult for the overall investment environment to improve significantly. We may be entering an environment where some prices are falling below operating breakeven. Let’s keep in mind, though, that energy is a big part of the cost of extraction and refining for most hard commodities. Miners and refiners will keep producing if there is a dollar contribution toward fixed costs. With the metals priced in dollars for the most part, the currency weakness many of these countries have seen is a further reduction in costs. It is possible as we get later into the year modest increases in demand combined with reductions in supply may shift the patterns. At the same time, it is highly unlikely that we will see major improvements in governance and economic results early in the year in these three countries mentioned. However, the tone has shifted. This is an opportunity for the US to affect the rate and quality of change in these three important South American countries with an impact on the whole continent. While the change in our relations with Cuba gets media attention, a similar reaching out by the current administration to change relationships with the three countries is a real possibility. One will be able to find all of the varieties of investment opportunities within the Americas with similar risk characteristics as exist throughout the rest of the world. This is a slight overstatement, of course, but just saying...