Outlook 2015: Multi-asset investment
In recent years we have danced to the central bankers' tune. With rates pinned at 0% we correctly judged that the path of least resistance, for developed equities in particular, was up. As we move into 2015, however, it might be time to sit some of the dances out.
Seeking assets that can withstand low growth
The desynchronised nature of the global economic recovery is to some extent good news: firstly, potential inflationary pressures in the US are being suppressed by economic weakness elsewhere; secondly, a strengthening US dollar is allowing other economies to ‘borrow’ some of America's dynamism.
The challenge is that in the absence of a more vigorous global economic recovery, it is difficult to rotate into the cheaper assets which tend to be more cyclical. This is why we remain stuck in a loop, endlessly chasing yield and pushing already expensive assets to even loftier levels.
Against this backdrop, we are shifting gears. Where previously we had emphasised ‘making hay while the sun shines’, we are now focused on avoiding potholes. Rather than relying on knee-jerk responses to central bank announcements, we prefer to focus on assets which can cope with anaemic economic growth. This leads to us to avoid credit-related asset classes due to expensive valuations and potential illiquidity. Yes, yields could keep on grinding lower but it feels increasingly speculative at this point.
Supportive earnings trends in some equity markets
Within equities, we expect performance to remain narrow and we are emphasising markets and sectors where corporate earnings trends are most well-established. To entice us into more cyclical areas we need to see deep discounts. The US, which is very much leading the recovery, continues to be one of our favoured markets. Ample liquidity along with earnings potential and growth momentum support our positive view.
We also take a positive view on Japan. Abenomics has led to a substantial depreciation in the yen while the increasing focus on corporate governance combined with a shift of asset allocation by the national pension fund towards domestic equities has provided a further boost to equities. Even though longer term the prospects for the domestic economy remain bleak, these policies are positive for many asset markets.
European growth continues to disappoint and even Germany is now suffering as emerging market weakness undermines its export markets. A significantly weaker euro is required to help mend the eurozone which will need greater decisiveness from the European Central Bank. Emerging markets remain stuck between disappointing growth in core exports markets in Europe and Asia and tightening US dollar liquidity.
Commodity correction may lead to opportunities
As we expected, commodities have struggled this year. While the cyclical backdrop is not supportive, we may find opportunities in 2015 given the correction we have seen already. Energy prices have fallen a long way and are now trading around the marginal cost of production but Saudi Arabia appears to be tolerating prices at this level as it enables them to gain market share. Metals prices have also suffered but should continue to receive some support from Chinese policy makers who maintain an easing bias.
Bonds to be buffeted by data noise
Government bonds remain vulnerable to oscillations in US labour market statistics but ultimately we believe that risks remain skewed towards deflation rather than inflation. Global growth momentum (with the exception of the US) is weak. Given this backdrop, we believe that Janet Yellen, chair of the Federal Reserve, is not under any immediate pressure to raise rates. In this environment UK government bonds provide a hedge against a further slowdown in growth momentum since gilts benefit from safe-haven flows if the economic environment in Europe deteriorates while they offer a more attractive yield than German bunds
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