This is why 2016 will be a dangerous year for investors

2016 promises to be a tough year for investors. They will have to contend with an array of dangerous cross-currents that will test nerves to the extreme. There will be few places where investors will feel secure as slower global growth, conflicting policy signals and increased market volatility make rewarding investment opportunities even harder to pick.

Financial market confidence will be running the gauntlet. Asset allocation looks extremely overstretched right now and, with fading fundamental appeal, investor confidence in over-cooked equity markets could end up in sharp retreat next year. Anything that upsets expectations about access to cheap and easy money in 2016 will take its toll.

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The global economic outlook carries lots of health warnings right now. While there has been a lot of positive carryover on growth expectations for the US, UK and Europe, thanks to QE’s legacy, the outlook still remains clouded in doubt. Risks are mounting that world growth could slip back into the doldrums in 2016.

The dramatic drop in global commodity prices this year and the 15 per cent collapse in world trade flows over the last 12 months are symptomatic of deep cracks in global demand. Certainly, the International Monetary Fund’s projection for world growth to pick up to 3.6 per cent next year from 3.1 per cent in 2015 looks highly questionable. There is a strong probability that world GDP growth will drop back below 3 per cent again in 2016.

The global economy is not rushing into a deep stall just yet, but the pace of economic activity definitely looks under threat, a key bearing on whether the six-year global equity rally sinks or swims in 2016. Hopes for faster growth are absolutely crucial for stock markets sustaining good forward momentum next year.

US Federal Reserve policy intentions are critical for market morale staying upbeat. Rising US interest rates are already under way, but this is only the first step back to normality. There is a bigger shock waiting in the wings from the likely changeover from quantitative easing to quantitative tightening at some future stage.

Ominously, Fed Chair Janet Yellen has already warned markets that the US central bank’s balance sheet will shrink ‘considerably’ once the US economy has reached maximum employment. We are not too far off that point right now.