Investment View January/February 2015
The election results in Greece should not be seen as a surprise. Other than the Swiss National Bank’s dropping of the Swiss franc currency peg to the euro, there have been few real surprises but the year has only just begun. Even Draghi’s ability to surprise the markets with the level of QE does not count: because he was always going to surprise. Maybe OPEC’s acceptance of the fall in oil price is a bit of a surprise but I guess they are playing a long game to take marginal producers out of the picture.
The Greek election is the first of many elections in the world that are to be held in 2015. The chart shows a list of key events that are taking place in 2015 that may have an impact on markets. The Greek election result is definitive and capital markets will ultimately respond once the negotiations with the rest of Europe develop. Europe, and Germany in particular are very much against revising debt terms or easing the severe austerity plan as that would set a dangerous precedent. Something will have to give, but few predict that Europe will be thrown into turmoil as a Greek exit from the Euro is not likely. That would be a huge surprise and cause turmoil in Europe and beyond. However, the Greek result and what now follows may set a trend that markets will be wary of as both Portugal and Spain have elections this year. Both countries are wounded, struggling to economically progress and suffer from high unemployment but certainly in better shape than Greece.
The European Central Bank’s announcement that it would start purchasing European government bonds should not have come as a surprise to anyone with even a passing interest in European affairs. The decision has been the talk of the market of late and leaks to the press have been explicit that a programme was on its way. The decision is a landmark moment for the ECB.
What might this mean for markets? Firstly, it intensifies the steady yield squeeze that has been a feature of global markets since October. With government bond yields across Europe now reminiscent of post-bubble Japan, investors are pushing into other parts of fixed income to find yield. The biggest beneficiary so far has been investment grade corporate bonds. Despite not being included in the new QE programme, corporate bonds will benefit from the displacement effect. The more sovereign bonds the ECB buys, the more traditional government bond buyers will need to look elsewhere. This is a prime reason for the ongoing performance of UK gilts and US Treasuries, which are attracting yield-hungry government bond buyers. The search for sovereign yield outside Europe and Japan has fed into local emerging-market bonds, where yields have steadily declined in recent weeks.
Elsewhere, the impact of oil has divided the haves and have-nots of energy – but in reverse. While stabilisation in energy prices is still key for energy producers, the last few days saw notably more steadying in these bonds markets. In fact, US and European high yield funds have seen a significant pickup in inflows recently. There is no doubt that even for the most experienced fixed income manager the landscape remains extremely challenging. We continue to believe that strategic and high yield bonds offer the best home for lower risk asset allocation apart from property which continues to look attractive.
For European equity markets, the ECB’s action has fired up the engine. Europe was the best performer since the announcement, with the German DAX now up 9% year to date. Broad European equity markets have now broken the weak trend that has been in place since last summer. This will be driven by two factors besides QE: firstly, signs of a cyclical rebound in the European economy helped by a weaker euro and lower oil price; and secondly, investor positioning, as many investors have been heavily overweight US equities and neutral their European counterparts. Valuations of European companies are supportive and corporate competitiveness is improving. Earnings should benefit from euro depreciation as well as the impact of lower energy costs on consumers and many businesses.
US equities are no longer cheap but the US economy has put the crisis behind it albeit economic data continues to be inconsistent but the direction of travel is clear. Although the market is relatively expensive, favourable economic fundamentals continue to support a steady uptrend in corporate earnings. Share buybacks provide a further return for investors.
In the Spring, the UK market will be dominated by the general election on May 7th. The result of the election is impossible to call but it seems inevitable that another coalition or similar will be required to form a Government. Markets hate uncertainty and that is what we are facing. At the last general election the UK market reacted negatively prior to the election and the reality is that we must be ready to endure that again. The UK market had a fairly dull 2014 overall but on closer examination the dispersion of performance between companies was immense and the value of a good active manager clear to see. The oil price, fall in energy prices and supermarket wars will effectively put a little bit of unexpected cash in consumers wallets. The impact of all this may result in periods of deflation but this is not seen as a negative. All in all this should have a positive benefit for UK companies albeit exports to our main trading region, Europe, have got more expensive. I am hopeful that earnings for UK listed companies will improve and the UK will have a satisfactory year.
In Emerging Markets performance is increasingly divergent; while some countries benefit from strong domestic fundamentals, particularly India, others are under pressure from politics, current account deficits and tighter policy to stabilise depreciating exchange rates.We are neutral on emerging markets, which generally underperform during periods of US dollar strength and continue to prefer a wider exposure to the Asian region.
January is a busy time for fund houses to present their views on the year ahead. The consensus is strong dollar, weak euro, oil price to remain low, strong property, challenging fixed income, equities to progress with Europe offering greatest potential and US likely to be first to raise interest rates but later than had been expected only a few months ago.