Monday, February 2, 2015

January 2015 QSO

We recently released the January 2015 edition of Quarterly Strategic Outlook.  This covers the broad economic and market themes we expect to play out in 2015 with asset class commentary from our Head of Investment Strategy Keith Poore.

The December quarter and year was a rewarding one for diversified fund investors. Fixed interest produced healthy returns on the back of some softer global activity data, increased asset purchases from the Bank of Japan, a sharp decline in oil prices and associated lower inflation expectations.

Returns from global equities were also generally solid thanks to gains in US and Japanese shares with both markets continuing to experience earnings growth and policy support. Returns from New Zealand shares were strong which coincides with the robust local economy; relatively high dividend yields and a low exposure to commodity stocks also contributed to local market gains. In contrast, a higher commodity exposure held back the Australian market.

Property and infrastructure were the best performing asset classes over the quarter. Given their income characteristics these assets continue to benefit from lower bond yields. A fall in oil prices led a large decline in commodities over the quarter. This was largely due to OPEC’s decision not to cut production in the face of slowing global oil demand. The New Zealand dollar moved higher over the quarter, especially against the Japanese yen, euro and Australian dollar as the market priced in central bank easing of one form or another from these regions.

2015 looks set to be characterised by continued ‘low-flation’ and the battle to avoid deflation.  The slump in the oil price has added a further dimension to the inflation story, while at the same time providing a welcome boost to growth in those economies continuing to struggle with weak demand.  Global growth is expected to be modestly stronger in 2015, although there are both upside and downside risks.

Oil presents a key upside risk to growth especially in the key oil importing economies.  But that will be determined by how much further the oil price falls and where it eventually settles.   Downside risks include a sharper property-related slowdown in China and continued sluggish demand in the Eurozone and Japan.  When the numbers are in and the dust has settled global growth for 2014 is likely to come in at around 3.3%, the same as last year.  In 2015 we expect growth will be slightly higher at 3.5%, followed by 3.7% in 2016.

Global bond yields surprised on the downside in 2014 and this is a major reason why the higher dividend asset classes (property, infrastructure, New Zealand shares) were the top performers in 2014.  We expect bond yields to move modestly higher over the next twelve months as the US takes the first small steps toward policy normalisation. Bond purchases by Japan and Eurozone central banks should limit the rise in yields globally.

We also expect the subdued inflation backdrop to be around for some time, so any rate rise in the US this year will be associated with higher growth. This will be positive for earnings growth and share prices given valuations are not overextended. Quantitative easing in Japan and Europe should also support shares in these regions. Nevertheless, global shares entered a flatter and more volatile return profile over the second half of 2014 and we expect this pattern to continue over 2015. A modest increase in bond yields should also result in a modest underperformance by higher yielding shares this year.

We expect the US dollar will follow US rates higher over 2015, and by implication push the New Zealand dollar lower. The recent sharp decline in commodities, while explainable, is now looking overdone given global growth will approach potential this year. Although commodity prices could go lower in the near term we believe the balance of risks have moved to the upside over a medium term horizon.

For the full document click here.