Market Update - January
Dull global growth, falling commodity prices and low inflation
The US continues to lead the economic recovery but growth momentum elsewhere remains below pre-crisis levels. Economic data would suggest more of the same in 2016; as measures of manufacturing activity remain subdued and global GDP growth appears to be stuck around 2.5%. China is clearly slowing and recent turbulence in the financial markets reflects concerns around both the economic reality and the anticipated policy response. Both commodities and currencies have been volatile. Commodity price falls have suppressed inflation and the outlook remains tough, although there could be opportunities after recent moves down. Reduced inflationary pressure has delayed the anticipated upward trajectory in US and UK interest rates.
Inflection point in US monetary policy
We have now seen the first interest rate rise from the US and expect the UK to follow suit this year. Within portfolios we remain focused on developed economy growth. This has been right but the challenge we now face is that quantitative easing and the prolonged period of near zero interest rates has encouraged more debt in the global economy and increased prices of most investment assets. It is clear that the Federal Reserve is keen to normalise interest rates without distressing financial markets. Whether they will achieve that goal remains to be seen, with deflationary pressures from the East building and oil prices falling.
Volatility to continue
Accordingly we expect a continuation of the volatility experienced over recent months as investor sentiment oscillates. This is enhanced by narrow bands of equity market performance (a small number of stocks leading the overall market) with those areas of the market where corporate earnings trends are most well-established performing well and out of favour areas continuing to underperform. Bond market volatility has seen a substantial spike, with a 60% increase in 2015 compared with 2014.
Implications for portfolios
Although supported by their safe haven status in uncertain markets, bonds tend to underperform in a rising interest rate environment. We expect history to repeat itself, particularly considering how low current yields are, and anticipate turbulent bond markets in 2016 so retain an underweight position. Liquidity in corporate bond markets is also a concern, and one that we are watching carefully.
Equity markets do still offer opportunities, particularly in periods of volatility, and valuations in general are not overly stretched. Divergence in economic fortune and monetary policy is likely to translate to currency and market performance. We therefore retain a modest bias towards European equities, where the cycle is earlier in its evolution compared to the US and the UK. Valuation opportunities exist in some of the out of favour sectors and geographies, such as resources and emerging markets, but we are trying to resist the urge of becoming too contrarian too early. Being different is often rewarding at turning points, but can also prove a drag on performance in the latter stages of a cycle when investing with the trend typically works best.
Diversification into property has added value over the last couple of years, generating strong capital and income returns. We retain our positions, although recognise that the best of the returns are likely behind us. Absolute return has a role in portfolios in dampening volatility, even if recent returns have been fairly subdued. As ever we remain disciplined and patient long term investors.
The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital Management does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital Management has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital Management is a trading name of Schroder & Co. Limited 12 Moorgate, London, EC2R 6DA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored.