“There are four key areas, in our view, where Australian investors need to tread carefully during 2016,” said Guy Bruten, AB’s Senior Economist—Asia. “These are resources and housing, inflation, and the potential for more market volatility as the global monetary policy landscape changes.”

Bruten said that the downturn in the resources sector during 2015 played out largely in line with expectations, but the offsets from a weaker Australian dollar and a resilient residential construction sector turned out to be greater than predicted.

While this meant that the overall outcome for the year was shaping up to be relatively positive, Bruten warned that this pattern would not necessarily continue through 2016. One of the risks for next year is that the downturn in resources intensifies just as housing activity peaks.

“In its latest statement on monetary policy, the Reserve Bank of Australia highlighted that we’re only about halfway through the adjustment in capital spending in mining,” said Bruten. “It’s gone from 8% of GDP to around 5%, and the central bank thinks it could fall to below 3%.”

This suggests that more job losses will flow from the sector. There are concerns, too, about the tax revenue benefits of some resource projects as they move from the investment and construction phases to become fully operational.

The Australian Taxation Office, for example, recently noted an “emerging concern” about the potential for tax avoidance within multinational oil and gas companies in Australia, because of the scope that exists to attribute sales and profits from Australian resource projects to offshore affiliates.

“Against this background, we need to ask ourselves whether housing in 2016 will come to the economy’s rescue in the way it did in 2015,” said Bruten. “I am not among those who see a possible housing crash, but I don’t think we can afford to be complacent.

“The last time it looked as though we might be heading for a housing crash was in 2003, when the background was very different—there was a very strong boost to the economy coming from commodities and from tax cuts, too.”

Bruten noted that inflation in Australia had remained relatively sticky during the last five years, when other economies had stepped down to core inflation rates of 1% or less.

“The headline Consumer Price Index reading for the September quarter was surprisingly soft—down from 0.7% in the June quarter to 0.5%, compared with an expected 0.7%. It raises the question as to whether we’re following other countries toward ultra-low inflation rates.

“At the very least, it suggests inflation could emerge as an additional complicating factor in the setting of policy—as it has in other economies such as Sweden and New Zealand,” said Bruten.

The fourth area where AB thinks investors shouldn’t be complacent concerns the potential for market volatility as the global monetary policy landscape changes next year.

“We’ve been expecting the US Federal Reserve to raise rates for some time now and to some extent that’s been factored into markets. But we don’t think that investors are sufficiently factoring in the possibility that the Bank of Japan might move next year to taper its quantitative easing policy.”

Bruten added that the European Central Bank (ECB)—which recently stepped up its quantitative easing programme—was supposed to end the programme in September next year. When that happened the focus would turn on what the ECB would do once it moved beyond quantitative easing.

“The only certain thing about 2016 at this point is that it’s going to be another year of uncertainty,” said Bruten. “The best way for investors to navigate that uncertainty will be to avoid becoming complacent about any aspect of the economy, monetary policy or local and global financial markets.”

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“Most people rely on gross domestic product or GDP as a measure of economic welfare, even though economists agree that it’s actually quite a flawed metric,” said Guy Bruten, AB’s Senior Economist—Asia Pacific.

“In our view, the GDP figures don’t really reflect what’s been going on in the Australian economy since 2011, when the commodities boom ended and our unusually favourable terms of trade—in which the prices we received for our exports were far in excess of what we paid for imports—began to fade.

“During that period, GDP slowed from 3.7% to 2.5% which, while lower, was hardly shabby. If you look a little deeper than GDP allows you to, however, the picture looks a lot more serious.”

According to Bruten, a better measure of the true state of Australian living standards is net national disposable income per capita (NNDIPC), which adjusts for shifts in terms of trade, population growth, net flows of income to overseas—including, for example, to foreign-owned mining companies—and depreciation of capital stock.

“NNDIPC shows that, after the huge swings of the 1980s, Australia settled into a remarkably long and consistent period of prosperity,” said Bruten (see diagram below).

“From the end of 1992 until the Lehman Brothers shock in September 2008, growth in household disposable income per person averaged a remarkable 3.2% a year, with very little volatility. The first half of the period reflects the payoff from the economic reforms of the 1980s, while the second half reflects the China-driven commodity price boom.

“But that era is now clearly over. Since the end of 2011, this measure of living standards has been going backwards at a rate of 1.4% a year—a reflection, largely, of the decline in the terms of trade.”

The chances of this situation improving during 2016 were slim, said Bruten, as there appeared to be “still some way to go” before Australia sees an end to the drag effect of the end of the commodities boom, and a pick-up in the non-mining sectors of the economy.

“The honeymoon for Mr Turnbull may be quite short, given the sobering economic environment dictating Australian households and business,” said Bruten.

“Our baseline scenario says that solutions to Australia’s problems will require both innovation and time, and it remains to be seen whether Mr Turnbull can shorten this process with his new approach to leadership.”

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In its second-quarter Global Capital Markets Outlook, the firm said it is tackling the uncertainty by implementing a broad, three-pronged investment strategy across the global asset spectrum

This consists of being “balanced in bonds, active in equities and making some portfolio allocation to alternative assets as a form of downside risk mitigation”.

Commenting on the economic backdrop to the Outlook, Guy Bruten, AB’s Melbourne-based Senior Economist—Asia Pacific, noted the divergence in economic growth and monetary policy between Australia and the US, with the Reserve Bank of Australia expected to reduce the cash rate again just as the US Federal Reserve is preparing to normalize interest rates for the first time since 2008.

“In Australia, the end of the commodities boom continues to play out in a familiar way,” said Bruten. “Capex is falling sharply as projects reach completion. Iron ore and coal prices continue their slide, pressuring profitability, domestic incomes and taxation revenue.”

Bruten noted that, despite the dearth of activity in non-mining exports or capital spending, the impact on the jobs market had been limited. “Looking through the noise, jobs growth has been in the 1-to- 1.5% range. While this is not bad, it’s not enough to stop the unemployment rate drifting higher.

“The key issue, in our view, is this: is the fact that unemployment has not deteriorated further an encouraging sign that ‘genuine rebalancing’ is occurring? Or is it built on a (temporary) burst of new housing activity?”

Anthony Chan, Hong Kong-based Senior Economist—Asia, said that, while the falling oil price had led to benign inflation in Asia, the region’s central banks had diverged on whether it was right to cut rates, with some (such as India, Indonesia and China) keen to lower rates but others (South Korea, Malaysia, the Philippines and Thailand) worried that doing so might overheat their economies.

“Given that inflation in Asia is structurally lower than in large developed countries, most Asian bond markets offer opportunities for relatively high real yields,” said Chan. “With the possible exception of Indonesia, Korea, China and Thailand, few Asian countries will come under pressure to raise rates once the US starts to normalize its own. That’s another example of divergence.”

In a high-level summary of its portfolio positioning in various investment strategies across different asset categories, AB said that, in fixed income, it maintains a balance between risk-reducing high- grade interest-rate securities and return-seeking credit-based risk, while taking a global and multi- sector approach in both rates and credit.

In equities, where the firm expects reasonably solid market returns over the next couple of years, it’s maintaining an active stance, seeing the importance of “being able to differentiate between winners and losers in capital markets as divergences occur. We are also overweight in risk-reducing equity strategies that may help navigate potential volatility.”

In alternative investments, such as long/short equities or credit, AB thinks exposures should focus on beta management or downside risk mitigation and alpha-driven absolute-return approaches which take advantage of divergences among securities and sectors.

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AllianceBernstein’s outlook for 2015

AllianceBernstein portfolio managers and economists expect that the investment playing field of 2015 in Asia and Australia will require fancy footwork—sidestepping macro risk while at the same time uncovering hidden investment gems.

Macro Overview: Dispersion to continue

Asia Fixed Income: Low risk, high liquidity

Asia Equities: Contrarian opportunities

Australia Equities: Stock selection is key

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