Market Outlook 2015 update

World Economy

The world economy will continue to demonstrate an uneven pattern, reflective of different policy settings as well as structural forces.

• For the US, the story for 2015 will be renormalisation with increasing of interest rates.
• For Japan and China, it will be monetary policy.
• For the Eurozone, price deflation to continue.

Regardless, whether and when the Federal Reserve will end its zero interest rate policy will once again become the focus of attention among investors and financial markets this year.

THE EQUITY MARKETS

The US economy is viewed to continue to lead the rest of the world, and the Fed will continue to be ahead of other central banks in terms of monetary renormalisation, that is interest rate hikes, albeit gradually.

US equities have the potential to be inflated further. It is viewed the bull market in US equities has not reached a major top. Fed policy remains accommodative and real short rates remain low. Therefore, it may seem too early for investors to position themselves for the arrival of a bear market in equities. Nevertheless, investors should be mindful that the risk-reward profile for equities has deteriorated as prices have continued to move higher.

The most likely outcome is that the bull market in US equities will enter into an unstable stage, where price fluctuations may be bigger than before.

China is joining Europe and Japan in easing monetary policy, which should be regarded as a welcome move by stock markets around the world.

Australia is experiencing some pressure as mining capital expenditure continues to fall and traditional economic drivers (especially credit fuelled consumption) struggle to generate solid growth.

We therefore perceive that this will be a year of below trend GDP growth.

Equities are likely to generate a reasonable return due to their elevated yield (plus franking) relative to alternatives such as AUD bonds, term deposits and at call cash.

In summary, equity markets should continue to reach higher, although increased volatility is to be expected.

BONDS

After a pause during 2014, bond yields should resume the process of reconnecting with the economic recovery started in 2013 when the US 10 year bond yield rose from about 1.5 per cent to 3 per cent.

Stronger growth both in the US and abroad, combined with a US economy now nearing full employment should force the Fed to begin raising the funds rate this year and push the 10 year bond yield towards 3 per cent by year end.

CURRENCY

A strong US dollar in 2015 is a widely held view by industry analysts. The Fed is preparing for rate hikes this year and the European Cental Bank and Bank of Japan looking at ways to extend QE.

This view already has driven the US dollar up by 8 per cent since July in real trade-weighted terms against the major currencies.

However, it is important not to get carried away with the bullish dollar theme. Aside from it being the view, the yen is already at 45 year lows in real trade weighted terms and the Eurozone has a large and growing current account surplus.

More USD strength is possible against the major currencies, but it's likely that the easy gains have already been made.

COMMODITIES

The oil price collapse should continue to be a tailwind for the consumer.

Europe, Japan and China are beneficiaries of lower oil prices.

However, declining oil costs on their own are probably not enough to drive growth.

Europe, Japan and China are considering more fiscal and monetary stimulus to get things moving again. Nevertheless, the drop in energy prices is a help for both businesses and consumers.

EMERGING

In relation to the emerging markets, value is at most attractive levels relative to developed markets in 10 years.

However, China is slowing, commodity prices have fallen and the rising US dollar is putting financing pressure on emerging countries.

A larger monetary and fiscal stimulus program in China and evidence that the EM currency adjustment is complete would be a positive.

Since last year China’s economic policy changed course, worried about debt accumulation and over-investment, the government tightened both monetary and fiscal policies.

The resulting slowdown in economic activity has forced Bank of China to recently cut interest rates and Beijing has also started to pump in stimulus in the form of various infrastructure-related investments. We expect this policy relaxation to continue during 2015.

The Bank of Japan will again have to step up its monetary reflation efforts. Monetary policy can only have an impact on the economy through a decline in the country’s foreign exchange rate. Therefore, in order to reach its 2% inflation target, the BoJ needs to manage a continued devaluation in the JPY.

We will remain cautious on EM equities, but with an eye on the longer-term value opportunity.

OUTLOOK

In Australia, a weakening A$, weak commodity prices, reduction in cash rates will elevate inflation and expect quarterly growth rates of 0.5%. Australian bond yields will continue a low levels despite inflation expectations of 3%. The A$ will give some relief to resource companies but the gains may be a year or so away.

Much of the developed world now has historically low yields on savings. 2015 will remain in a low growth cycle.

US & China will remain solid with both being beneficiaries of lower commodity prices.

2015 looks to be a year when active investment choices will matter, especially given central bank policies and differential growth rates across the globe. It should be a year that suits the use of actively managed globally diversified, multi-asset strategies.