The Lowdown on Markets to 2nd January 2015
In this week’s issue
- Government bonds outperform equities in 2014. Wrong-footing many investors.
- Amongst the developed equity markets Wall Street reigns supreme.
- Commodities remain subdued as global growth expectations disappoint.
- China and India benefit from government reforms and the fall in crude oil prices.
- Will this be the year when the US dollar reinforces itself as the world’s reserve currency?
- Will 2015 finally be the year when we see a rotation out of bonds and into equities?
What does this mean for the markets and asset classes?
“The pain trade took its toll in 2014 but unlikely to happen in 2015”
As global equity markets get under way for 2015 it will be interesting to see whether the long awaited rotation out of bonds and into equities finally happens this year. Arguably, most investors had positioned themselves at the start of last year for a pickup in growth meaning that most were long equities and short bonds; regrettably, as the year progressed, growth proceeded to disappoint whilst geo-political risks mounted over Russia’s invasion of the Ukraine and the collapse in the price of crude oil.
Surprisingly, the central banks of the US and UK continued with their loose monetary policies, which in turn, generated a strong performance in government bonds seeing the yields on 10-year paper of US Treasuries and UK Gilts close out the year at 2.11% and 1.72% respectively. Similarly, in Germany and Japan the belief that further quantitative easing was imminent saw their respective bond yields fall to 0.50% and 0.33%.
Clearly, for many investors the so called “pain trade” of being overweight equities and underweight bonds in 2014 took its toll on performance unless you were heavily exposed to the US equity market the dollar, China, India and some selected frontier Asian markets. Certainly, this unaccustomed asset allocation mix might have given an investor a similar return to that of government bonds.
Certainly, growth has slowed over recent months with forecasters revising down their estimates for 2015. Further sharp falls in many commodity prices such as oil, wheat, iron ore, copper and coal has led to further concerns around the future direction of inflation, indeed, many of the leading central bankers have become very mindful of it fall over the past 18 months voicing some concerns over the prospect of deflationary period.
Unquestionably, this has led to some further pessimism in regions such as the eurozone and Japan leading to many market watchers predicting that the ECB and BoJ will anchor their interest rates lower for longer and will further reinforce their fiscal policies with additional quantitative easing.
Equally, the US economy is likely to see further growth whilst inflation remains benign, likewise in the UK; however, we are facing an unpredictable outcome to the General Election in May 2015 and an unclear picture as to the possibility of further austerity, whoever wins.
Obviously, the market pundits are already predicting where the FTSE 100 Index might be by the end of 2015, and of course, the range is wide with some forecasting the market as high as 7,500. My only concern with this Index is its narrowness in terms of its constituents, clearly, we would need to see a turnaround of fortunes in the likes of Oil & Gas, Basic Materials and Financials given that these three sectors represent 35% of the index, and then if you add the sectors of Personal & Household Goods and Healthcare, the percentage rises to 55%. Similarly, the five largest weighted companies within the index, HSBC, Royal Dutch, BP, Glaxo and BATS represent nearly 25% of the overall index.
Whilst this level of concentration might work in your favour at certain times the performance of the FTSE 100 Index over the past decade versus that of the FTSE 250and FTSE Small Cap Indices has been disappointing given that the wider choice of good quality growth companies within mid and small caps has been much more rewarding.
Clearly last year’s unforeseen out performance of bonds over equities, encouraged by further central bank intervention; was surprising, however, it would be difficult to see a similar outcome over 2015. Admittedly, we are likely to see further monetary policy announcements from the ECB and BoJ, but this is to be expected, and therefore should be positive for their markets, further weakening off their respective currencies to the benefit of their exporters.
Arguably, any further acceleration in growth in the US, or the UK, should to be positive for their markets whilst lower oil prices will create winners and losers around the world. Understandably, the exporting nations will suffer, but those nations that import energy will benefit, indeed, the savings for household real incomes is like an additional tax break giving consumers extra money to spend.
Understandably, there are still some concerns surrounding the global economic recovery whether it be due to eurozone deflation, a hard landing in China or an unforeseen geo-political event, however, global growth in 2015 should slowly pick up allowing central bank policy to normalise over time. In respect of asset classes, whilst their remains a chance that bonds will wrong-foot equity investors again the likelihood is that the rotation out of bonds and into equities will gain some momentum as we go through the year.
Peter Lowman Chief Investment Officer
Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum he worked within larger asset managers, primarily as an Investment Director within Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Investment Committee.
This article does not constitute specific advice and investors should bear in mind that capital invested is not guaranteed.
Investment Quorum is authorised and regulated by the Financial Conduct Authority.