Marino Valensise, head of Global Multi Asset Group and chairman of the Strategic Policy Group at Baring Asset Management comments on the changing role of Central Banks in 2015 and the implications for asset allocation.
In the last few years, the willingness and ability of central banks, and governments in general, to suppress volatility and minimise economic and market risk have not been questioned. There has been a strong belief that authorities will not allow excessive market movements, and that they would avoid or manage any sudden changes which would derail economic recovery and employment.
The dramatic fall in the price of oil and – more recently – the sharp rise in the Swiss franc both signal that, in certain situations, market forces are uncontrollable and that even central banks might fail in curbing volatility. The market has already been very anxious about a probable increase in interest rates by the US Federal Reserve, and this had created expectations of higher market volatility. Recent turmoil in the energy and foreign exchange markets has confirmed investors’ expectations of a choppier ride in 2015 and a new volatility regime in the coming months.
In terms of economic growth, the new year should be better than the previous one, barring any systemic shocks. The US economy continues to improve, which is evident in its employment data. American real economic growth should be around 3% in 2015, with the country being the main beneficiary of lower energy prices. Things should improve in Japan, while Europe might continue to lag. We expect emerging markets to continue growing at a decent pace; however, growth has recently been under pressure due to some country-specific situations, and the strong US dollar represents a threat to their prosperity.
Global corporate earnings are expected to grow around 9% in 2015, which should make investors happy. However, earnings expectations have deteriorated slightly in the last few months, due in part to the energy sector, which has started to suffer from lower oil prices. The sun has been rising on corporate Japan, which is not only anticipating healthy earnings growth of approximately 12% but is also enjoying upward revisions to earnings.
2015 will be an important year in three key ways.
First, it will be the year in which the US Federal Reserve raises rates. Despite deflationary signals from the fixed income market and some mixed economic data, we are convinced that the Federal Reserve will raise rates between June and September, as employment continues to be strong.
Second, it will be a year of important elections in Europe. This is true not only in Greece but also in Spain, where both the separatist Catalans and the new left-wing party Podemos pose a threat to the political status quo.
Third, it will be the year in which the European Central Bank starts expanding its balance sheet again through “Sovereign Quantitative Easing”, which would involve the central bank purchasing the sovereign debt of Eurozone nations.
This is a strategy which works on four different levels: it signals the bank’s determination to do ‘whatever it takes’, it adds liquidity to the system, it tries to weaken the euro and it might lead to banks and investors rebalancing portfolios away from government bonds and towards corporate loans and equities.
We continue to be positive on global growth and corporate earnings. We remain positive on the US economy, which has been improving for a while. However, we recognise that a number of potential vulnerabilities exist. Some of them might affect US earnings, such as the strong US dollar and lower energy capital expenditure). Others might affect the US equity market, like the volatility which would follow a rate rise and the impact of too many investors taking positions in US equities. Given the role of the US market in setting the tone for equities globally, we decided to downgrade equities to neutral.
From a country perspective, we confirm our preferred view on Japanese equities. We have downgraded US equities to neutral, bringing this market in line with others such as the UK, Europe and emerging markets.
A key theme for us is the attractiveness of equity income in a world where bond yields have collapsed. This might prompt a portfolio reallocation in favour of dividend-paying equities, particularly in markets where the equities are yielding significantly more than bonds. In our view, Europe is the market which could benefit the most from this trend.
From a sector perspective, we have upgraded Consumer Staples and Consumer Discretionary to neutral, as these sectors should both benefit from greater consumer purchasing power in light of a lower oil price. We have downgraded Healthcare to neutral; the sector has performed well for a prolonged period of time, but might suffer somewhat from the recent move in the Swiss franc.