Last year we saw volatility rise across and within asset classes, and increasingly differentiated trends in the global economy.
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.