17th December 2014
Investment Quorum’s chief executive Lee Robertson looks at the challenges facing investors next year.
Clearly we experienced an extremely mixed year with the first three months being plagued by geo-political events such as the Ukraine, fears surrounding growth in the Chinese economy and confusing dialogue about interest rates which led consequently to some de-risking of portfolios by the selling of equities in favour of government bonds.
Then global equity markets began to act more favourably as a clear divergence between the leading central banker’s around the world became more apparent, as they spoke of improving economies, monetary stimulus, job creation, healthy manufacturing data, consumer demand, and a robust housing market.
Conversely, the second half of the year saw investors focus upon the withdrawal of QE in the US, further monetary stimulus in the Eurozone, and Japan, and mounting concerns about the global economic recovery, this led to a sharp falls in the price of crude oil, the Russian rouble, and the yen, whilst the reserve currency of the world, the US dollar, began to strengthen.
Fast forward to the end of the year the effects from a 40 per cent fall in the price of crude oil is taking its affect, providing differing consequences for many countries’ and economies around the world. Indeed, for the largest oil importers around the world such as China, India, Japan, and South Korea the creation of cheaper oil will be of huge benefit, whilst the larger exporters such as Saudi Arabia, Russia, Iran, Iraq, Nigeria and Venezuela will experience a significant fiscal headwind.
Equally, in the UK the fall in the oil price will help the chancellor, George Osborne given that we are an importer of oil, and cheaper prices at the pumps, declining food prices, and low mortgage costs is freeing up cash flow to the consumer to spend within the economy. Admittedly, the falls in energy and commodity prices might become a longer term concern for central bankers, given the latest falls in inflation, and mounting risks from disinflation.
A continuation of loose monetary policies and further quantitative easing programmes within many of the western economies has extended the bull market in sovereign bonds, which in turn, has “wrong footed” many asset allocators and fund managers, given that at the start of this year it was thought that bond markets would begin to suffer from rate hikes, and plainly this has not happened in 2014.
Equally, it was thought that global equity markets would benefit from the great rotation out of bonds and into equities, once again, this supposed rotation has not really happened; none-the-less, returns on Wall Street have been very rewarding helped by better economic news, likewise, China, and markets such as India and Japan based upon newly elected government reforms.
Conversely, western sanctions on Russia, and the fall in crude oil prices has taken its toll on their economy, and currency, with the rouble falling to a record low against the US dollar. Obviously, the Russian central bank tried to protect the currency by spending a considerable sum but have nowdecided to let the currency float freely, intervening only if the market moves posed a threat to financial stability.
Unquestionably, the threat of further retaliations from Russia cannot be ruled out as we enter 2015 and in Vladimir Putin’s recent annual state of the nation’s speech at the Kremlin he said that Russia would prevail against attempts by the West to weaken it. The Russian president went on to say that the Crimea, which Moscow annexed from Ukraine in March had “sacred meaning” for Russians.
Crimea was like “the Temple Mount in Jerusalem for the followers of Islam and Judaism”. He said that if Moscow had not seized control of Crimea, the west would have “found another excuse for holding Russia back and Russia down”.
In general most asset classes this year have reacted more towards central bank policy and geo-political risks rather than the true fundamentals such as corporate profits.
Looking at the MSCI World Equity Index, which has a 50 per cent weighting towards the US, versus the Federal Reserve Bank Balance Sheet, it is apparent that global markets have tracked the US Central Bank monetary policies whilst the MSCI World Index 12 month Forward Earnings Index has plateaued, admittedly, corporate earnings have seen a pick-up in 2014 which would have narrowed the gap but clearly the old saying of “Don’t fight the Fed” has been the most powerful tool in the tool box.
Whilst we never wish to be cornered into making predictions some of the macroeconomic issues we will have to contend with as investors for next year are summarised below.
Expectations are for the Fed to announce interest rate hikes in mid-2015 or September 2015. Indications are that the US will continue to lead global growth, driving short term rates higher.
Dovish policymakers globally may compete as the Fed’s tightening cycle progresses, leading to more US dollar strength.
US unemployment rate down to 5.8% with the November numbers smashing the job forecasts.
The recovery has stalled and inflation may decline further eventually prompting more European Central Bank action and very possibly sovereign quantitative easing.
On that particular subject it is likely that the ECB will announce Sovereign QE in January or March 2015.
It is expected that we will see a continuation of UK growth, but low wage inflation, currency strength
and the weakness in Europe as a headwind. It is possible that we might see a delayed action with regards to rate normalization until at least February 2015 or beyond, possibly until after the General Election in May 2015.
The economy has slowed as policymakers continue to try to balance growth and longer-term structural reforms. Wage inflation is eroding China’s competitiveness, and concerns remain about credit growth and
The economic impact of the VAT hike has caused inflation to slow but it is expected that the trend will resume its upward trajectory in the New Year. With the snap election over Abe now has a clear mandate to continue his policies and with the second round of tax hikes delayed for 18 months the growth outlook is likely to improve heading into 2015.
To summarise it looks like 2015 will be just as exciting, unpredictable, uncomfortable and potentially rewarding as 2014.