2016: What Could Potentially Cause Volatility In the New Year

Evaluating market performance charts

Over the last few days, as is customary at this time of year, I have been looking at sectors and individual stocks that could outperform the market in 2016, or at least in the first quarter of the year. The thing is though, no matter how logical those picks seem now, their fate, and that of the market overall, will most likely be determined by some big picture, outside influences that will dominate thinking throughout the year.

This year, for example, the continued collapse in commodity prices, the strength in the dollar, and the Fed shifting to a rising rate environment have been the dominant factors in market moves. That led to a stock market that essentially finished the year flat, meaning that the default direction for stocks this year should be upwards. The logical question, therefore, is what is lurking in the background that could affect markets negatively in the coming year.

Some will no doubt be hangovers from 2015. As it becomes clear at what pace the Fed is prepared to move going forward many questions will be answered. If, as Fed Chair Janet Yellen has frequently maintained, the pace of any future increases remains extremely slow, then the worst of the dollar strength will be over.

That in turn will give some relief to commodity prices and this year’s stories will fade away. If, on the other hand, rates move faster than the market has already priced in, then the higher dollar will add to the pressure on commodities as well as manufacturing businesses in the U.S., there will be a continued squeeze in the high yield markets and volatility in the stock market will be commonplace.

If we assume that the former will be the case then we can be pretty sure that something else will emerge to worry markets. It always does. The most likely cause for concern in that case is likely to come from outside of publicly traded stocks and debt. Tech start up valuations began to get a little frothy in the middle of the year and still remain elevated. This is understandable as the rewards for being an early investor in the next Google (GOOG) or Facebook (FB) are huge, but the comparatively weak IPOs at the end of this year could be a sign that that “bubblette” is deflating. If that is the case, then high multiples for existing companies will begin to look frothy themselves and a significant selloff in tech could be the result.

Internal factors such as tech valuations can be a worry, but in some ways they are predictable. The real short term shocks to markets tend to come from political and geopolitical events outside markets, however, so the fact that it is an election year should be borne in mind. There seems to be no discernible pattern as to how the market performs in election years; it depends on who the candidates are and who is leading.

That said, a strong showing by Republicans usually produces a positive response in stocks while the opposite is true if a Democrat leads the polls. That was the case in 2012 when a selloff followed the election results. Interestingly though, as is often the case, that seemingly had more to do with market participants’ fears than reality as once Obama’s second term started stocks had a good year in 2012.

Both the Fed’s actions and the election could have short term, relatively minor effects on stocks this year, but if there is to be a big blow-up then the stimulus for that is likely to come from outside America’s borders. You have only to look at the chart for the S&P 500 for the middle of this year to see what effect any increased worries about Chinese growth could have. Similarly any escalation in the Middle East, especially if the result of high profile terrorist attacks either here or abroad could result in a sustained drop in markets which, like the nation itself, are accustomed to but tired of war.

To me, though, the biggest worry and potential drag on markets throughout 2016 will come from Europe. It is popular at the moment to be bullish on European stocks as the divergence in policy between the ECB and the Fed comes fully into effect. The problem is that, despite the success so far of The ECB’s version of QE in warding off deflation the policy is still unpopular among several European countries, most notably Germany. That could easily result in a premature tightening by the central bank and a hasty retreat by all of that money drawn to Europe by the current policy. Should that happen then the problems that still remain in Greece could come bubbling back to the surface.

Any or all of these things could derail stocks this year, but history tells us that if a shock is to come it is most likely to come from something that is currently completely off of the radar. In other words, there are an endless number of things to worry about over the next year. So, with that in mind, I would like to wish you all a happy New Year!

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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