Which asset classes will ride out volatility?

The US recovery remained intact, but concerns across the emerging world escalated and bond markets placed a question mark over central banks’ ability to manage the cycle.

Cross-asset volatility rose, and in aggregate terms, market returns (equities and bonds) were moderate. However, at the sub-asset class level, material returns could be made in specific markets.

A number of key themes will drive asset prices. A big debate is whether global growth is entering a phase of secular stagnation or moving towards continued recovery. Inflation trends will also be key, as will the question of how synchronised global monetary policy can be. Another issue is the role of earnings growth driving market returns, given that valuations can no longer be relied upon following the re-rating of the past few years.

The trend in the developed world is expected to be towards cyclical growth, with the US growing above potential and the eurozone continuing to grow as the seeds of an investment cycle have been sown. The developing market cycle will continue to be both less predictable and heterogeneous.

Core inflationary pressures are likely to slowly re-emerge (particularly in the US and UK). Inflation will, however, remain low and will broadly enable monetary policy to remain highly stimulative, but interest rate policy will become less synchronised as the Fed raises rates on the back of tightening labour markets and the eurozone does the opposite to manage inflation. This will create volatility in foreign exchange and bond markets, but moves will be well signalled and modest.

US corporate earnings are likely to struggle due to declining margins and potential currency headwinds. The outlook in markets like Japan and Europe is more constructive.

Across a number of asset classes, valuations have re-rated in recent years and we are likely entering a phase where investors should expect a multi-year period of lower nominal returns. Nevertheless, the view remains that the equity risk premium is still attractive and in aggregate, equity returns will be superior to bonds.

The profit and margin cycle is at different phases across the world, and a primary factor differentiating returns will be the ability to deliver underlying earnings growth.

A preference for areas that have lower earnings expectations, scope for margin expansion and cheaper starting valuations means the eurozone and Japan stand out.

The developed market cycle will remain intact and asset class-level returns are likely to be low, with equity markets outperforming bonds. The trends that lie beneath will be more extreme. The global economic cycle will continue to be heterogeneous, monetary policy is likely to become less synchronised and dispersion within asset classes will be high.

A number of the trends mentioned are likely to cause volatility in fixed income and currency markets and there is a risk that this feeds through to equity markets.

Potential risks that need to be monitored include central bank credibility coming into question, a deterioration in US earnings and the emerging market slowdown becoming more systemic. These factors are likely to create a volatile journey where returns will be moderate, but significant opportunities exist.

Toby Vaughan is head of fund management, global multi-asset solutions at Santander Asset Management

Investment trust outlook

QuotedData research director James Carthew says: “2015 was a great year for new issues, with 23 funds coming into our universe, 40 per cent of which were investing in the burgeoning debt sector. We expect to see more of the same early in 2016.

The renewable infrastructure sector took a knock in the summer as the UK government slashed subsidies but, as Bluefield Solar recently commented, there is a big pipeline of potential acquisitions of projects that got in under the wire and room for further growth in that area.

[But] 2016 could be a good year to be contrarian. There are swathes of funds exposed to commodities, Asia and emerging markets that really suffered in 2015 on the back of slowing Chinese economic growth. Might they be due for a rebound?

Given all the uncertainties, such as Brexit and the war in the Middle East, we can see why there might be considerable demand for funds that try to keep volatility low and/or focus on absolute returns.”

Japan outlook

Genzo Kimura, economist at SuMi Trust, says: “The Nikkei 225 is expected to surpass 22,000 in 2016. Stocks to watch include Toyota, Fuji Heavy and Kao, as sectors exposed to US auto sales, aviation and inbound tourism are set to benefit from improved economic conditions in the US.

Shinzo Abe will maintain his majority in the Upper House 2016 elections, with Abenomics continuing to govern economic policies. However, should the promised wage hike not release the bottleneck in Japan’s economy, Abenomics could come under scrutiny.”