Professional Adviser - More grey hairs for 2015?
One of the downsides of being a global strategist is that there are an endless number of things that can keep you awake at night. Of course, good preparation and long experience generally help you deal with the anxiety and tensions. However, there are still lurking threats that are never possible to exorcise entirely.
One omnipresent risk for markets is politics - difficult to price in at the best of times but even more so when some of the potential outcomes are so stark and divergent. Political uncertainty is likely to be an important theme again in 2015, especially in relation to the Eurozone. Although the market reaction to the recent Greek election victory of anti-austerity party Syriza has been sanguine, ongoing difficulties with the reform programme in Italy and France, and the outcomes of the Spanish and Portuguese elections in the fourth quarter of the year, are likely to present sterner tests. Other political issues which could be important include the potentially complex result of the UK election, the tense Russia/Ukraine situation, and the IS advance in Syria/Iraq. The key issue for investors is that risk assets are priced for relatively good growth in 2015, meaning political shocks to earnings expectations would be priced in quickly and sharply, as occurred several times in 2014. On balance, that suggests that central banks will need to keep their tendency or bias towards lenient policies for some time to come.
It is not just the political x-factor that is likely to worry investors over the coming 12 months. Confidence in the global recovery remains relatively weak. Can the US and China grow sufficiently to pull the rest of the world economy along, in due course allowing the US to raise interest rates? Alternatively, does the slowdown in other areas, especially the Eurozone and some larger EM economies such as Brazil and Russia, restrain global growth too much? Another way of considering this is the effect of lower oil prices: do they boost consumer spending more or lead to sharp cuts in energy sector production/employment/investment as well as adverse financial effects on over-indebted businesses and economies? In other words, are the benefits of lower oil prices to be saved or spent? A final issue is the likely efficacy of the ECB's decision to widen QE from private into public bonds. We can see the impact on financial asset prices, and the spur for the carry trade to continue, although we remain to be convinced that the follow through into a turnaround in real economy activity will be that significant. Headwinds to monetary transmission in the Eurozone are still significant. Having considered all these issues, our House View debate has emerged relatively positive, allowing us to add to risk during some of the indiscriminate selling in financial markets in recent weeks.
Perhaps the biggest potential source of reassurance in the year ahead would be a further improvement in corporate earnings. The House View has emphasised time and again that risk assets, such as equity, real estate and credit, can be bought by global investors as long as profits growth remains positive, which is likely even in a slow growth world. Valuations are relatively stretched in some assets though, notably US equities, so companies need to be able to reassure investors about cashflow and dividend payments/cover. However, we remain overweight/Heavy in risk assets, especially developed versus emerging market assets. A strong dollar, falling commodity prices and muted global trade are not a great backdrop for many stocks in the EM universe. One area of client demand to monitor is real estate, where demand is picking up on the grounds that imbalances to end the business cycle are not yet in place, or where they exist they are not yet sufficiently large; examples would traditionally include inflation pressures, currency account problems or a surge in credit growth. 'If only' some politicians and central bankers might say!
In conclusion, there is a feeling of déjà vu as we enter 2015. Global economic growth has failed to reassure investors, but the potential for improving momentum in the 12 months ahead remains relatively high. While we certainly worry about the risks that political events pose, these political cycles are frequent - and for all the angst they cause we have coped so far. Finally, if companies continue to eke out better profits then market valuations will be supported. In a world of falling bond yields, credit and higher yielding equities look more attractive. So reasons for cheer then, although whether this will be enough to silence the worrier in all of us completely may come down to each individual’s constitution!
Andrew Milligan, Head of Global Strategy, Standard Life Investments
First published in Professional Adviser – February 2015