Questions That Will Move Markets

November 30, 2015

4. If commodity prices stay low, who benefits?

The easy version of this question is: What will happen to commodities, including energy, next year? Uncertainty regarding Chinese growth makes this a difficult question to answer. Will the Chinese return to infrastructure investment as a key lever keep GDP strong? Will the government let growth drift lower and rely on reform and consumer spending to fuel growth? Those are easy questions to ask but difficult to answer.

Instead, the first question seeks to find long-term winners from commodity price declines. The iShares MSCI India (INDA | C-96), the iShares MSCI Japan (EWJ | B-98), the Vanguard FTSE Europe ETF (VGK | A-97) and other commodity importers benefit from lower prices.

India, in particular, has the capacity to grow more quickly with less inflation if commodity prices remain low. Japan and Europe benefit from lower prices too. Make sure prices are analyzed in local currencies. Prices could fall in dollars but rise in euros if the dollar continues to appreciate.

5. Which global governments will surprise the world with meaningful reforms that benefit investors?

Brazil’s government is the one most worth watching. Dilma Rousseff’s administration has struggled with slowing Chinese growth, corruption and persistent inflation. Any reforms from this administration could reverse Brazil’s poor market and currency performance. The iShares MSCI Brazil Capped (EWZ | B-96) would be my choice for investing in Brazil if reforms become a reality.

Italy is another market to monitor. Italian economic reforms slowed in favor of political reforms designed to improve the stability of Italian governments. Once those political reforms are in place, a new election is likely and then economic reforms become possible to implement. The political reform proposal will face key hurdles in 2016, but if approved, the opportunity for additional economic reforms improves. The iShares MSCI Italy Capped (EWI | C-90) is the most liquid Italian ETF. Depending on the outlook for the euro, the Deutsche X-trackers MSCI Italy Hedged Equity (DBIT) may also be attractive.

6. Will military tensions raise the risk premium and undercut the advantages of globalization?

Niall Ferguson, in his book, “The Ascent of Money: A Financial History of the World,” describes how the financial world was caught off guard by the onset of World War I. Investors assumed countries with so many economic linkages would be hesitant to go to war with each other. I hear the same logic from investors now.

This line of thought ignores how China, Russia and other formerly communist countries are relying on nationalism to replace communism as the political ideology that justifies limited democratic reforms. Chinese nationalism is driving a greater degree of brinkmanship in the Pacific and fermenting greater nationalistic feeling in Japan.

While military engagement is unlikely, even the potential for sanctions, trade barriers and other responses offer the potential to move markets.

Conclusion

Predicting questions is probably safer than predicting events, although not much. None of these questions feeds the day-to-day drama that warrants top billing on financial websites. But they will be questions I monitor to better navigate markets in 2016.


At the time of writing, CLS Investments held positions in IEF, TLT, LQD, HYG, SCHD, VYM, INDA, EWJ, VGK, EWZ and EWI. CLS Investments is an Omaha, Nebraska-based third-party investment manager and ETF strategist. CLS began to emphasize ETFs in individual investor portfolios in 2002, and is now one of the largest active money managers using exchange-traded funds, with more than $2 billion invested. Contact CLS’ Chief Strategist Scott Kubie at 402-896-7406 or at [email protected]. Please click here for a complete list of relevant disclosures and definitions.

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