26th November 2015
In our view it is important to acknowledge that, as uncomfortable as it may be to admit, no one can be sure about the future. However, while we cannot claim to know what lies ahead, we can make some key observations about the current investment landscape.
Volatility to persist
When we look back at 2015, the most striking feature was the return of market volatility, most notably in equities and emerging markets, but evident across most asset classes and regions. During certain phases we experienced dramatic market swings, sometimes over intra-day periods. This seemed at odds with trends in data - in developed markets at least - indicating ongoing economic recovery. Our sense is that the clearest explanation for this dislocation between price action and fundamentals is that investors, still traumatised by the shock of the Global Financial Crisis, are struggling to have faith in this growth and will require very strong evidence for a prolonged period to accept that a deep-seated recovery is indeed underway. With sentiment so fragile and sensitive we expect volatility to persist for some time yet. However, it is important to remember that short-term volatility does not always equal long-term risk, and often presents compelling opportunities for those with the emotional fortitude to take it on.
Policymakers in the spotlight
The unprecedented levels of intervention by Central Bankers since 2008 means markets have become highly sensitive to their words and actions in recent years. We expect the likes of Yellen, Draghi and Kuroda to remain in the headlines into 2016 as, on the one hand, US policy makers try to nudge up interest rates without spooking markets, and on the other, the European, Japanese and Chinese policy makers look to additional measures for boosting growth. All of this means we find ourselves in an environment that appears unstable, with a great deal of focus on what policy-makers will do next.
A divided world
When we look at the global economic landscape today, we see a major division between Asia and emerging markets on one side and the US and Europe on the other. Asia and emerging markets are experiencing a clear slowdown. By contrast, the economic news coming out of the US and Europe continues to indicate robust recovery. Although the situation in emerging markets represents genuine fundamental risk to certain regions, the extent to which it is likely to affect domestic demand in the developed world is, we believe, limited, certainly relative to the impact of a decline in the economy of a major developed country. This means we maintain a positive outlook at the global, aggregate level. However, this combination of a general lack of belief in global growth, and attempts to untangle meaningful messages from every policy statement (no matter how seemingly meaningless), leaves investors with a lot of different factors to weigh up. We think this is causing a great deal of confusion around how any asset ‘should’ be priced in the current environment. We anticipate this confusion will continue to drive periods of material mispricing – and hence investment opportunities – across asset classes.
Oil slump may yet be felt
Over the past 12 months or so, we have been among those believing the decline in the oil price to be a net positive economic factor at the global aggregate level, in terms of the effective tax-cut it provides to businesses and consumers. However, we expected something of a lag before the effect was felt. Consumer indicators in the West appear to be showing that it has begun feeding through recently, which we think is likely to continue into 2016. This further bolsters our central view that the fundamental environment is supportive for growth and therefore, risk assets broadly. Lower commodity prices also contribute to our view that inflation is likely to remain low, allowing policy makers to remain accommodative even in a growth environment, although we do believe inflation could start gradually picking up in certain areas over the months ahead.
Equities our favoured asset class
Our positive outlook for global growth means equities remain our favoured asset class overall from both a fundamental and valuation standpoint. Certainly, most equity markets are not as ‘cheap’ as they were two years ago but there are still opportunities. However, with the world so divided, it is vital to be selective within asset classes. In our view, European and Japanese equity is priced for stronger prospective returns than US equity – although certain areas of the US market, such as banks, looked attractive, especially given the potential to perform well in a rising rate environment. Some emerging market equity also seems attractively priced, but the level of genuine fundamental risk means we are engaging with these assets more modestly.
Bond yields should rise
In recent years the consensus view that the global economy is struggling – despite evidence to the contrary – has driven mainstream bond yields to what in our view are unjustifiable lows. We believe mainstream government bonds are generally overvalued. The fact that the collapse in the yields to generational lows has persisted for so much longer than could be expected highlights how difficult it is to predict when this situation will change. Nonetheless, we do expect yields to rise in 2016 and we are watchful for opportunities in this space.
For now, peripheral-European and select emerging market debt seems to offer attractive levels of yield. In terms of emerging market debt, we are mindful of genuine risks and potential sensitivity to US interest rate rises. However, our observation is that when something is so widely accepted as the assertion that “emerging market debt sells off when US rates rise”, much of the risk may already be in the price.
Expect to be surprised
It is interesting to look back at the topics that dominated headlines over 2015 and how these changed suddenly from week to week or day to day. The Ukraine crisis, Grexit, Brexit, Chinese slowdown, US rate rises, European political noise, and so on. This highlights how what worries investors most from one moment to the next can change, but also how the things that move markets are often the things that few predicted. Most of these issues are still unresolved, even if they have faded into the background for now. So any one of these topics could flare up again in 2016, or it may be something else entirely. The point is that we should not put too much emphasis on economic forecasting. We believe the most sensible thing to do is expect to be surprised, be mindful of what our fundamentals-based convictions are before volatility takes hold, and be ready to respond to the risks and opportunities presented once it does.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Steven's views are his own and do not constitute financial advice
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