Stocks ended 2014 and began the new year on a lacklustre note.
As we turn the page on another year and survey the global landscape, one important theme stands out: the various regions of the world are starting 2015 in very different positions.
This has important implications for investors this year.
Starting with the US, the economy seems to have ended 2014 on a strong note, and leading indicators suggest that growth should continue.
Third-quarter US GDP was revised higher to 5 per cent, the best pace we have seen in 11 years.
More importantly, forward-looking indicators suggest the momentum should continue. The Chicago Fed National Activity Index – an indicator with a particularly high correlation to future growth – has just registered its best reading in eight years.
Stronger growth buoys corporate earnings and generally should support stocks. However, there are exceptions to this. Most notably, it may put pressure on defensive stocks, many of which outperformed in 2014.
This is particularly true for utilities companies, often viewed as a bond-market proxy.
In 2014, the utilities sector benefited from the unexpected drop in interest rates. This year yields are likely to remain low, but we do expect some increase in rates, a process that has already begun for shorter-term Treasury bonds.
Rising interest rates are a negative for dividend plays, such as utilities, because higher rates have historically been associated with lower valuations. This is particularly problematic today, with the sector trading at a premium to the market. Historically, utilities have traded at a steep discount.
In Europe, the situation is very different. Markets are caught between the counter forces of growing geopolitical risk and the upside potential from further easing by the European Central Bank.
In Asia, the focus is on supporting growth through whatever means are necessary and available, including central bank easing in China and structural reforms in Japan.
Against this backdrop we would point to a few key themes to start the year.
First is the relative economic strength and less accommodative central bank policy in the US in contrast to weaker growth and more aggressive monetary policy in the rest of the world.
This has several investment implications, including the prospect of a stronger dollar. Should the dollar continue to appreciate, that would exert more downward pressure on commodity prices.
Last week oil traded at its lowest level since 2009, natural gas traded at less than $3 per million British thermal units for the first time since 2012 and copper hit a four-and-a-half-year low.
Second, with defensive stocks already at high valuations and vulnerable to any rise in rates, we would favour a more cyclical stance within US equities. We continue to see opportunities in ‘old technology’ firms and in financials.
Finally, look for markets with tailwinds, either in the form of monetary stimulus or structural reforms. This includes in both developed Asia (such as Japan), as well as in emerging markets within that continent.
Russ Koesterich is global chief investment strategist at BlackRock
