2015 market outlook
Stanley Yeo, IOOF Portfolio Manager, Strategy and International Equities
The world economy will continue to demonstrate a highly uneven pattern, reflective of different policy settings as well as structural forces: For the US, the story for 2015 will be re-normalisation. For Japan, it will be monetary reflation. For the euro zone, deflation will be the dominant story, while for China it will be policy relaxation.
Regardless, whether and when the Federal Reserve will end its zero interest rate policy will once again become the focus of attention among investors and financial markets this year.
As for the markets, US equities have the potential to be inflated further, turning the bull market into a bubble. We do not believe that the basic macroeconomic backdrop has changed very much from last quarter. In other words, the US economy will continue to lead the rest of the world, and the Fed will continue to be ahead of other central banks in terms of monetary renormalisation. The only difference here is that China is joining Europe and Japan in easing monetary policy, which should be regarded as a welcome move by stock markets around the world.
After a pause during 2014, bond yields should resume the process of reconnecting with the economic recovery started in 2013 when the US 10 year bond yield rose from about 1.5% to 3%. Stronger growth both in the US and abroad combined with a US economy now nearing full employment should force the Fed to begin raising the funds rate this year and push the 10 year bond yield towards 3% by year end.
Investors should be cautious in the corporate high yield market. Recent evidence suggests that this asset class has parted ways from the equity market: while the S&P 500 has made a series of record highs, high yield spreads have actually widened. This is partly because the high yield market is weighted heavily in oil companies and energy plays, and has been impacted by falling oil prices.
A strong USD in 2015 is a widely held view by industry analysts. It's hard not to see the logic with the Fed preparing the ground for rate hikes this year and the European Central Bank and Bank of Japan looking at ways to extend QE. This view already has driven the USD up by 8% since July in real trade weighted terms against the major currencies. However, we believe it's important not to get too carried away with the bullish dollar theme. Aside from it being a consensus call among industry analysts, the yen is already at 45 year lows in real trade weighted terms and the Eurozone has a large and growing current account surplus. More USD strength is possible against the major currencies, but it's likely that the easy gains have already been made.
The oil price collapse should continue to be a tailwind for the consumer. Europe, Japan and China are beneficiaries of lower oil prices. Declining oil costs on their own are probably not enough to reverse recent growth weakness. All three are considering more fiscal and monetary stimulus to get things moving again. Nevertheless, the drop in energy prices is equivalent to a major fiscal tax cut for both businesses and consumers. On the other hand, the oil price collapse will increase default risk of sovereign, quasi-sovereign and private sector issuers in countries with inadequate reserve funds and inadequate non-commodity exports. Oil may soon find a floor but the cyclical prospects for a speedy recovery are poor.
In relation to the emerging markets, value is attractive, with the sector at its biggest price-to-book value discount relative to developed markets in 10 years. However, the cycle keeps us cautious. China is slowing, commodity prices are falling and the rising US dollar is putting financing pressure on current account deficit countries like Brazil and Turkey. A larger monetary and fiscal stimulus program in China and evidence that the EM currency adjustment is complete would make us more positive. Until then, we will remain cautious on EM equities, but with an eye on the longer-term value opportunity.
2015 looks to be a year when active investment choices will matter, especially given divergent central bank policies and differential growth rates across the globe. In particular, it should be a year that suits the use of actively managed globally diversified, multi-asset strategies. In this low-return world, a wide source of opportunities and a nimble process will be crucial when navigating the investment landscape in the year ahead.
Where do you see the markets going in 2015?