Markets experienced considerable volatility in 2015, which saw significant weakening of commodity prices driven by a slowing Chinese economy and, consequently, concerns over global growth. As a result, it was a more challenging year for investors. In the few years prior to 2015, since the recession, positive returns could have been made from owning virtually any asset class or index. However, 2015 highlighted the importance of asset allocation and stock selection. For example, avoiding oil, mining and gas would have significantly boosted the return on the FTSE 100. Similar themes to those seen in 2015 will in our view continue in 2016, impacting market sentiment; Chinese growth concerns, central banks’ monetary policies, global deflation and a strong dollar. Domestically, the UK is also faced with uncertainty over its future in the EU.
Chinese Economic Slowdown
The most talked about economic story in recent months is the Chinese economic slowdown, which has adversely affected global markets and increased volatility. Furthermore, they are loosening their grip on the currency. Unsurprisingly, markets are failing to grapple with the unknown official growth figures of China, which does not look like changing in the short term, so we expect continued market uncertainty.
Much has been said about the ‘BRICS’ – Brazil, Russia, India, China and South Africa. All but one of these economies (India) have been facing significant headwinds, which could spill over to the rest of the world economy. According to World Bank Group, a 1% decline in growth of the BRICS reflects a decline of 0.4% over the following two years in the global economy.
In Q4 we finally saw the much anticipated first rise in US interest rates of 0.25% after seven years, which was welcomed by global markets, reflecting the continued improvements to the US economy. Investors’ expectations are that the UK will not follow suit until 2017, despite a healthy labour market and greater consumer confidence. Managing market expectations and appropriate timing of rate rises will be important in mitigating market volatility.
Conversely, we are still seeing monetary easing in other parts of the developed world, most notably in the Eurozone and Japan, in an attempt to stimulate economic activity. Japan’s QE program is one of Shinzo Abe’s arrows in his so called ‘Abenomics’ reform, attempting to inject inflationary heat back into the economy. So far this has been unsuccessful and is not solving the fundamental economic problems in Japan, such as its unsustainable public debt which is at around 250% of GDP.
Deflation has been a strong theme for the last year or so, caused largely by the collapse in commodity prices, due to a lack of global demand (notably China) and oversupply. This acts as a large tax cut for consumers and lowers transportation costs for businesses. As a result, consumer confidence in the US and UK is now exceeding the levels seen before the 2008 crisis. Arguably another cause of deflation is the excessive QE we have seen since 2008. This goes against conventional economic theory which suggests QE brings about inflation due to more money and liquidity circulating the economy. However, excessive money supply has led to the misallocation of resources due to the availability of cheap credit and, in turn, deflationary pressure which has been passed around the global economy via a political hot potato.
Although a low oil price is good for the consumer goods market in many economies, it is a major headwind for developing nations which rely on oil revenues, such as Venezuela, Brazil and Russia which face deteriorating industries and worsening budget deficits.
A Strong Dollar
To make matters worse for many emerging economies, a significant portion of their national debt is denominated in dollars, which, due to its strengthening, has magnified the level of debt repayments.
Although many argue that the US market is overvalued, for sterling investors, a strong dollar vs sterling has magnified returns this quarter and throughout the year (as shown in the table below). As a result, our exposure to US equities has remained unchanged this year. However, the more the dollar strengthens, the less competitive their exports become (everything else remaining equal), which will squeeze profit margins.
The debate over whether or not Britain should remain as part of the EU could cause ongoing uncertainty, so a vote sooner rather than later would be beneficial for UK investors. As a result, we have been favouring domestically focused UK stocks which are benefiting from the strengthening UK economy, have resilient earnings and are less subject to the uncertain situation should we exit the EU.
We retain a cautious outlook for markets going in to 2016 given the number of global economic headwinds outlined above. However, uncertainty presents opportunity for patient investors, due to mispricing of assets. We still favour quality equities with resilient earnings and strong cash flows, as well thick profit margins and pricing power capable of dealing with bumps in the road.
We expect the UK economy to continue to improve, although there will undoubtedly be nervousness leading up to a vote on the EU, which could be as early as June depending on Cameron’s negotiation efforts. Whether or not we will see a rate rise in the UK in 2016 is looking increasingly less likely and indeed the market expects them to remain unchanged. Investors will be keeping a close eye on the Fed who will need to carefully manage expectations of further rate rises in 2016, although this is likely to be very gradual. We expect further turbulence in Asia and emerging markets in the short term, however recent events might have started to open up some opportunities for long term investors. Finally, we expect relatively positive investor sentiment to remain in European equities in light of further QE expected in 2016 and measured improvements to the Eurozone economy.
|Market||Index||Performance 2015 Q4 (% change) GBP||Performance
2014 Q4 – 2015 Q4 (% change) GBP
|Performance 2015 Q4 (% change) Local currency||Performance 2014 Q4 – 2015 Q4 (% change) Local currency|
|Eurozone||FTSE Europe Ex-UK||6.17||5.48||6.16||8.60|
|UK Gilts||FTSE All-Stocks||-1.83||0.22||-1.83||0.22|
Our Strategic Asset Allocation
|Portfolio||Cash/Bonds %||Equities %||Alternatives (e.g. Property/ Infrastructure) %|
Bonds/Cash: 50, Equities: 39, Alternatives: 11
Bonds/Cash: 25, Equities: 65, Alternatives: 10
Bonds/Cash: 30, Equities: 56, Alternatives: 14
Bonds/Cash: 25, Equities: 65, Alternatives: 10
Bonds/Cash: 5, Equities: 87, Alternatives: 8
Bonds/Cash: 2, Equities: 91.5, Alternatives: 7.5
Our approach is to help our clients benefit from attractive equity returns and target sustainable dividends from a diversified portfolio, on the basis of our diligent research and analysis to highlight interesting investment opportunities and mitigate risk as far as possible.
[Jonny Rusbridge, Seabrook Clark Ltd, 4 January 2016]
Please note, our Investment Commentary is our view of markets and does not constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch.