The ‘low and slow’ challenge

This article is part of
Outlook for 2016: What’s in store?

The global economy in 2015 was supposed to have seen accelerated growth, but instead remained almost the same, largely due to the deterioration in emerging markets and a weak first quarter in the US.

Investors should be prepared for a continued ‘low and slow’ scenario: low growth, subdued inflation and limited policy tightening are on the cards.

The growth story is not over, nor is a bear market on the horizon, but investors would be wise to be more selective. This means looking beyond broad equity exposures to find pockets of opportunity; and choosing instruments and strategies that target specific regions and sectors to weather market volatility.

Maintaining a nimble and responsive portfolio is more important than ever. Key areas to focus on include:

1.Evolving portfolio construction: Integrating smart beta factors such as value, size and quality within equity portfolios can help sharpen return objectives.

2.Manage volatility: Global convertible bonds tend to benefit in volatile environments thanks to their embedded equity option and the bond floor that can help mitigate tail risk. They have the potential to reap the rewards of equity market rallies while offering downside protection.

3.European and Japanese equities: The eurozone is finally gaining some traction. GDP rose by 0.4-0.5 per cent in three of the last four quarters. Euro consumer spending has accelerated and the European Central Bank (ECB) is continuing its accommodative monetary policy. Potential opportunities in Europe include:

lCyclical sector investing: Sectors expected to do well include consumer discretionary, financials and industrials.

lSmall caps: These have fairly high exposure to the consumer discretionary and financial sectors, expected to benefit from quantitative easing.

lSmart beta strategies: Dividend-focused indices that seek exposure to companies with stable or increasing dividends offer more sustainable yield.

Looking to Japan, the central bank has remained firm on increasing inflation and fuelling growth. Equity markets are expected to continue to benefit from an accommodative policy environment, low wage pressure and shareholder-friendly corporate reforms.

Investors in Japanese equity strategies may wish to investigate currency-hedging options to manage the impact of currency losses on their portfolio.

4.US equities: Bottoming oil prices, low inflation and the strong dollar dealt a blow to US earnings over 2015. However, these are likely to be temporary headwinds. US equities may not be the top performer heading into 2016 but, with the economy expected to expand by 2.5 per cent, there is still plenty of room for growth. Opportunities include:

lCyclical sector investing: Resilient consumers and a Federal Reserve rate hike should continue to support and fuel growth in the consumer discretionary and financial sectors.

lMid-caps: These companies tend to be more geared to economic expansion.

5.Fixed income: In the US and Europe, low government bond yields and the desire for protection from rising rates in the US means investors may have to explore more credit-sensitive sectors, including high yield and investment grade corporate bonds.

6.Emerging markets: The outlook for emerging markets remains uncertain. Should confidence return, investors could consider both tactical and long-term diversified exposure.