Every month Seven Investment Management gives us their view of the major investment markets. This month they’ve gone even further and look even further forward.
What does 2015 have in-store for the major economies of the world and consequently your investments and pensions.
Read on to find out.
The year that has just passed was one that managed to confound most expectations. It would have been a bold strategist who this time last year, forecast the oil price to halve from $112 per barrel. Yet, at the time of writing, it is just under $50.
Similarly, no one was looking for a significant fall in yields in quality government bonds. There was an almost universal prediction for a gentle rise through 2014; yet the UK 10 year gilt has fallen from a yield of 3% to back under 2%. The story is the same in the US, and Germany has seen even bigger declines due to low inflation in the Eurozone.
Politics and geopolitics are always hard to predict, but a few of the headlines have been even more outside the box than usual: Russia annexing Crimea; the closeness of the Scottish Referendum vote in the UK; the US recognising Cuba once more; the rise of ISIS in the Middle East…A year like 2014 only serves to illustrate that specific events are very rarely foreseeable, and their impact on financial markets even less so.
Nevertheless, attempting to identify broad trends in the direction of markets and economies is not a pointless exercise. In the next few pages we’ll paint a broad roadmap for the near future, as we see it currently with our “strategic” hat on. Then as investment managers, we can act much as a sat-nav does, adjusting the route as new facts emerge about traffic, tolls and speed cameras.
2015 – A bumpy ride but more ups than downs
- GDP growth should continue to gather pace, as both Europe and Japan get their economies going, to add to relatively strong growth in the UK and US
- Monetary policy is going to remain loose. Although 2015 may see the first interest rate increases for a long time in the US, this should be balanced by asset purchases beginning in Europe (i.e. the European Central Bank will be starting a quantitative easing – ‘QE’- programme)
- Government bond yields are around all time lows. The risks are now more than ever skewed towards a painful rise in yields. The absence of this caught investors out in 2014, including ourselves. Nevertheless, the moves of the past twelve months only increase our belief that government bonds are riskier than they seem
- Investors want to start weaning themselves off the QE drug. Everyone is looking for fundamental growth stories to emerge, rather than being solely reliant on loose monetary policy. Therefore, signs of economic weakness (particularly in the US) are going to be greeted with dips in sentiment and prices such as we saw in the last few months of 2014. Looking through the headlines to the real picture will be important – we believe that economic growth really will return
Looking in more detail at the various regions:
US
Energy sector keeps pumping. The majority of US wells are profitable even with oil at $60 per barrel, particularly given the fact that construction and drilling are already sunk costs – making the operating breakeven price even lower. There is likely to be some contraction in energy and energy related sectors due to the decline in oil price – but this should come from a decline in capital investment, rather than bankruptcies and unemployment. Indeed the energy extraction sector has only added 60,000 jobs since 2009, a very small fraction of the 10 million people who have entered the work force over that period.
Return of the retail consumer. US consumers have been given a significant increase in disposable income, thanks to the decline in gasoline prices. This is a different beast to the low interest rates which have been in place for five years – the poorer section of US society tend not to be in a position to take advantage of cheap borrowing, due to a lack of financial assets and weak credit ratings. A saving on fuel costs is more tangible, and leaves more money at the end of the month. Most of which is likely to be re-injected into the economy through purchases – not of stocks or property, but of TV’s and fridges.
Corporate earnings continue growing. As unemployment falls, wage costs will slowly creep up – something that should bring profit margins down. However, increased volumes due to the rise in purchasing, hinted at above, should compensate for this in many areas.
Election fever is likely to ramp up towards the end of next year, and usually paralyses decision-making in the US. However in the past few months, President Obama has been ramping up his involvement in politics (climate change, immigration and Cuba), rather than gracefully retiring onto the speaker’s circuit. There is a possibility that the President could have some more headlinemaking surprises during the last 12 months of his final term – a rapprochement with Iran perhaps?
Federal Reserve keeps talking before walking. Janet Yellen is clearly in no rush to raise rates and when the time does come to do so, the size of the increase is likely to be small. We expect something akin to the approach to “tapering” – a statement of intent, followed by a period to let the news be digested long before the event.
Europe
A shaky start. Greece begins the year with an election that could potentially see a new government formed – one that intends to write off its debt, and loosen austerity measures. While this is unlikely to spiral into the same kind of Euro break-up crisis as 2011, it will doubtless bring up bad memories, keeping cautious investors away from European stocks. However the majority of Greeks (approx 70%) would like less strict austerity, but not at the cost of complete Euro exit.
Low inflation lingers. With the oil price half the level of a year ago and food prices approximately fl at, two key drivers of inflation are missing. In addition, high unemployment levels give little incentive for companies to increase wages. Equally, given that companies have survived the past three years, there seems to be little incentive to start cutting salaries now, particularly with growth picking up in the rest of the world. So, stable earnings and declining prices should lead to a pick-up in consumption, potentially further boosted by borrowing at extremely low interest rates.
Super Mario takes charge. Mr Draghi’s time has come. Two years and a half years after the “whatever it takes” speech (and with a Greek election on the table again!), the time is approaching when the European Central Bank may have to demonstrate just how effective its war-chest is. In order to maintain confidence and growth momentum, some form of explicit asset purchase programme seems likely in the first half of 2015 – perhaps government bonds, perhaps corporate bonds, or even ETFs could be bought.
Economic growth is better than expected. Consensus for EuroZone GDP growth in 2015 is around 1%, with expectation skewed to the downside. We have something of a contrarian view at this moment in time – European countries should benefit from an easing of austerity, the lower oil price, a weaker currency (particularly against the Dollar) and monetary stimulus. Add to that a stronger global demand environment, and the outlook is brighter than gloomy headlines of Greek elections, Russian tanks and high unemployment would have you believe.
Japan
Let’s go round again. Prime Minister Abe won the snap election in December, giving him another four year mandate to implement his structural reform program.
Growth must show its face. The deferral of the sales tax hike until 2017 has given some breathing space for the economy – but has also removed any excuses for further slowdowns. We expect that the combination of slowly rising wages and lower energy costs should begin to drive the Japanese economy forward once more.
Race to innovate. During its decades of stagnation, Japan lost the edge to various other exporters of things like heavy machinery and cars. Where it does still maintain a competitive advantage is in highly technical areas – robotics, alternative energy and electric cars for example. Some Japanese companies have recognised this already – Panasonic is one of the leading component makers for the Tesla S – and hopefully we will begin to see others follow suit.
Bank of Japan keeps pumping monetary stimulus into the economy. Prime Minister Abe and Governor Kuroda are clearly of the same mind; rates will stay low and asset purchases will continue. Given the difference in monetary policy between the US and Japan, a further weakening of the Yen vs Dollar is the consensus forecast.
We feel that this may not be as clear-cut as it seems – for example significant flows of foreign money into Japanese equities could keep the rate much closer to current levels.
UK
Economy up, unemployment down. The UK economy has now been surprisingly strong for two years and is now growing at around its long-term rate of 2.5% a year. Weak demand from Europe has been holding the UK back over recent years, but this should begin to improve towards the latter part of 2015. While we expect unemployment to continue declining towards 5%, the journey may be more gradual than the past 18 months – much of the low hanging fruit has already been picked.
UK elections. Predicting election results in the UK has never been easy. May 2015 is likely to be the most difficult in recent history. No-one is sure whether the UK Independence Party is a gimmick or a true threat come election day. The Liberal Democrats are likely to have their worst result for decades, but may still end up in power! The Conservatives have overseen a Coalition that has been relatively impressive politically, but now finds itself on the back foot. Labour meanwhile, lacks inspiration but is attracting votes regardless. The Scottish National Party is something of a wild card when it comes to its role in any potential coalition.
EU Membership? Clearly important, but very little to be said until after the General Election.
House prices to go sideways. There is still a tail of buyers left over from the financial crisis – those still renting, or living at home with parents. However construction of residential property has increased rapidly over the past couple of years, and this supply should begin to meet the residual demand.
Mark Carney makes no move. As long as inflation remains low, Mark Carney will find an excuse to keep interest rates at 0.5%. There will be strong pressure from the government (of whichever flavour) not to crush consumer spending through a rate rise. If growth begins to take off, Mr Carney will most likely begin focussing on some other metric that “justifies” looser policy.
Emerging markets
China is opening up. Headlines on Chinese GDP growth slowing miss the rather large point that total Chinese GDP is now huge. If a $9 trillion economy can grow at 5-6% for the next decade, we’d be very happy – and this looks like it will happen. In addition, little by little, foreign investment is being encouraged and financial markets are becoming more open. Also, with commodity prices falling, China looks very well placed to tackle 2015.
Asian economies stand on the shoulders of giants. For smaller Asian nations, 2015 looks promising too. Not only are their inputs (oil, coal, iron ore) becoming cheaper, but there are three massive economies poised to provide tailwinds – China, Japan and the US. India too, is looking as if it could finally fulfil its historic promise – and some of the demand from those 1.25 billion people will trickle into Asia too.
Commodity exporters face some challenges. Several emerging nations were relatively untouched by the financial crisis in 2008, but were reluctant to make necessary reforms. Many of these countries – Brazil, Russia and South Africa stand out as members of the BRICS – have economies based around export of raw materials, and are now facing a difficult period. Reforming in times of prosperity is unwelcome. Reforming in an economic downturn may be necessary, but can cause revolutions. Political tension is likely to rise.
Our actions
Given our belief that global economic growth will improve, we will continue to prioritise equities over government bonds, We will prioritise those stock markets with more attractive valuations. Europe is of particular interest in the respect, but we have so far refrained from taking significant additional action pending the outcome of the Greek general election.
We will have to decide whether the US stock market is going to be the primary beneficiary of US economic growth, or whether this is already priced in and, actually, its trading partners have more potential upside.
Emerging Markets are visibly cheap and, within that asset class, we will maintain our bias towards Asia in the nearterm. Japan should continue to generate interest among investors but we would begin to doubt the effectiveness of current policies without some more meaningful economic growth.
Within fixed income, higher-yielding asset classes have come under pressure recently and now look more attractive, in particular Emerging Market bonds. Given the recent strength of the US Dollar against Emerging Market currencies, there is likely to be an opportunity for Emerging Market currencies to rally at some point during the year. The degree to which our portfolios benefit is likely to depend on how well we manage their exposure to the US Dollar itself. We are currently fully unhedged on the basis that the pound will stay at current levels or below. Our opinion takes into account the recent strength of US data, plus the current bout of UK housing market weakness, as well as the potential for greater uncertainty ahead of the general election.
This document has been produced by Seven Investment Management from internal and external data. You should not rely on it as investment advice or act upon it and should address any questions to your financial adviser. The value of investments can vary and you may get back less than you invested.
