In late 2014 there was a palpable sense of nervousness in global financial markets.
In spite of the improving economic picture in the US and UK, investor sentiment continued to be held at bay by falling inflation, weakness in the eurozone and concerns over global economic growth.
In addition, two developments in the closing months of the year had a dramatic impact on the outlook and strategy for multi-asset investors: a steep fall in oil prices and a small change in the US Federal Reserve’s policy statement.
Global energy supplies soared in 2014 as the shale oil boom in North America pushed energy production above the growth rate of global demand.
Oversupply had already caused oil prices to start falling midway through the year, but the price of the commodity fell more sharply when the Organisation of the Petroleum Exporting Countries (Opec) announced in late November that it would not cut production.
Coinciding with the energy price shock was a change to the US Federal Reserve’s policy statement. In describing how long interest rates could remain at current levels, the Fed said it “can be patient” in lifting interest rates.
During the previous tightening cycle in 2004, the Fed said increases would occur at a “measured pace” and kept its word by moving at 25 basis-point increments over two years. While lower inflation expectations caused by cheaper oil could keep interest rates low, the rapidly healing labour market could prompt the Fed to move.
A key challenge for investors this year will not only be navigating the fallout from energy markets, but also a potential hike in short-term interest rates by the US Fed and the Bank of England. While history suggests this could increase volatility and bring on a meaningful market correction, at times in the past the equity market has performed well when rates rose from low levels.
In terms of positioning, the outlook for US equities remains solid, although a downturn has now become more likely given how far the market has travelled since 2009.
While it will be difficult to match the returns seen in 2014, there are still a number of factors that could boost equity performance in the coming year, such as stronger consumer confidence, a rising housing market and improving employment figures.
Equity valuations are slightly above average by historic standards, but they are unlikely to interfere with a potential market advance.
Meanwhile, Europe has continued to struggle with its debt crisis. Deleveraging in both public and private sectors has resulted in increased reliance on central bank stimulus as the solution to the region’s financial troubles. Nevertheless, structural change in Europe is leading to increasingly compelling opportunities for investors, such as consolidation among French telecoms and Irish banks.
Conversely, emerging markets continue to be unattractive. US dollar strength and rising short-term interest rates will have a negative impact on emerging markets that have taken on US dollar-denominated debt.
This burden has quietly grown since the financial crisis as governments have continued to borrow even as consumers and the corporate sector have deleveraged. Now many emerging markets will be funding themselves at higher short-term rates and servicing their debt with more expensive US dollars.
While risks remain, there continue to be opportunities in international financial markets. Increased monetary stimulus, weaker currencies, lower oil prices and the completion of the asset-quality review in Europe should all become tailwinds. In addition, continued strength in the US and potentially increased fiscal stimulus in various regions may help to lift the global economy and propel a market rebound.
Jason Vaillancourt is co-head of global asset allocation at Putnam Investments and co-manager of the CF Canlife Total Return fund
KEY FIGURES
Jason Vaillancourt from Putnam Investments notes income remains a key driver for many investors.
“There is still huge global demand for income-generating investments at a time when US Treasury yields are significantly higher than those of the sovereign bonds of Germany and Switzerland, not to mention weaker credits such as Spain or Italy.
“High-yield debt could be attractive as well because, outside of the energy and mining sectors, attractive valuations have been partially restored by the widening of spreads that has occurred over the past six months.”
