More of the same – with added volatility
Written By Noel O' Halloran, Chief Investment Officer
During 2014 we recorded new highs for global equity indices as well as recording the sixth year in a row of positive returns from global equities. This was achieved despite many headline challenges be they geo-political or simply the ongoing challenges of the muddle through growth struggle for many of the world’s economies. From my general perspective, this constant ‘barrage of challenges’ to the recovery scenario was to be expected and has been a feature of the global equity recovery since March 2009. Global bond markets have also continued to hit new highs confounding all negative predictions (including yours truly) once again.
For 2015, I believe we can expect more of the same, albeit with more volatility than recent years. While the global equities have been in a bull market now for six years and is therefore quite mature, I don’t believe the bull market is over but do believe investors should expect more modest single digit returns for 2015. The lesson from recent years have been that while ‘hits’ have been many and frequent they are transient and eventually overcome by improving fundamentals and central banks that keep the recovery underpinned....so buy the equity dips!
Why more modest returns?
- The key reason is that equity valuations are no longer cheap and I believe that returns should be more in line with global earnings growth – which I expect to grow by 6%. Over recent years strong double digit returns were driven both by earnings growth and an upward revaluation of P/E multiples. Although this re-rating could continue, it’s not my central expectation. This also underpins my strong preference for high but sustainable dividend yields as a component of total return.
- Earnings themselves have become more dependent on top line growth as the impact of significant margin improvements over recent years lessens. In a muddle through growth environment for many economies, robust top line growth is not to be expected
- One key reason to expect higher bonds and equity volatility is that the Federal Reserve (Fed) will change course and commence raising US interest rates this year. The US itself has been a strong driver of the market and economic recovery and low US interest rates have underpinned this. We don’t expect the Fed will make a policy mistake but that’s not to say that markets won’t experience another one of their ‘transient wobbles’ when it happens
What will we be watching?
- Top of the list over the first quarter will be the euro (again). Click here to see our separate blog of Jan 7 for our views re same
- The dramatic oil price fall of late has been a significant market feature. I expect the majority of the fall is now complete and my running assumption is that the oil price stabilises around current levels in a range, perhaps for a number of quarters
- Global central banks have remained the bedrock of the global recovery and while the Fed may change direction in 2015, I don’t expect the global central bank underpinning to change. While much negative energy will likely be expended worrying about the Fed, a corresponding positive may emerge in the form of the ECB embarking on a more radical quantitative easing programme, the Bank of Japan continuing to stimulate and many Emerging Market economies may surprise with more stimulative policies (both fiscal and monetary easing).
- The markets to date have had a very nervous and negative reaction to the rapid oil price fall. They haven’t yet however put enough emphasis on the positive benefits of this fall.Over coming quarters, I expect we will see improved consumer spending, enhanced profitability in sectors such as transportation, and improved growth in countries (often Asian) which are large importers of oil. Lower inflation from lower oil prices will be written up as ‘deflationary’, but it is a benign deflation that actually benefits rather than hurts the beneficiaries. So while the damage to certain sectors such as oil stocks or countries such as Russia has been immediate, I think the beneficiaries haven’t yet been properly rewarded. Indeed, from our perspective many sectors with little direct exposure to oil have been severely overly-punished we would argue, and provide opportunity for investors.
- At a regional level, having been hit with many concerns over recent years, Emerging Markets are increasingly off the radar of global investors. I feel that they are becoming a forgotten asset class. Against a background of attractive valuations, reasonable fundamentals and a real possibility of interest rate cuts, Emerging Markets could be a surprise winner for 2015.
- Another beaten up asset class for the contrarian investor to consider is broad commodity investments once more. They certainly could perform much better in an environment of increasing confidence surrounding global growth and a move to a more ‘risk-on’ environment. I’m not convinced at this point but perhaps one to revisit through the year.