Tuesday, April 21, 2015

Quarterly Strategic Outlook - April 2015

This week we released the April edition of Quarterly Strategic Outlook.  The executive summary is posted below or you can find the full document here

The first quarter of 2015 has been another solid one for diversified investors. The start of the year is looking like 2014 déjà vu as US first quarter growth has come in weaker than expected, central banks have eased more than expected, and bond yields have moved lower while equities have rallied.

The key theme for investors last quarter was the divergence in monetary policy expectations. The European Central Bank (ECB) and other central banks have eased more than expected while the US is still on course to commence rate hikes. This has driven the US dollar (USD) higher and most other currencies lower. Because the US Federal Reserve (the Fed) has trimmed its expected policy tightening the net effect has been lower US bond yields as well as lower global bond yields. An unprecedented level of quantitative easing, lower rates and lower oil prices have been a boon to share markets so far, especially Eurozone and Japan shares. Eurozone shares are also benefiting from a pick-up in growth and the long-heralded recovery in earnings.

New Zealand share returns have also been healthy with reasonable earnings and higher dividends contributing to the positive economic backdrop. Following a relatively weak 2014, Australian shares started the year well. A lower Reserve Bank of Australia (RBA) cash rate, combined with a weaker currency and increased dividend payouts, are all playing a part. Commodities continued to decline in the first quarter on rising inventories in key sectors and generally softer China data, but it looks like oil prices may have found a bottom at current levels. The stronger USD saw the New Zealand dollar (NZD) modestly lower against the MSCI-weighted basket of currencies over the quarter, but this masks strong gains against the euro, yen and Australian dollar (AUD).

The outlook for the global economy continues to be best described as “uneven”. Despite a weak start to the year, underlying economic fundamentals continue to improve in the US. That should see the US along with New Zealand remain one of the stand-out performers amongst the developed economies. Economic and financial conditions continue to gradually improve in the Eurozone and Japan, but growth is expected to undershoot the stronger performers by a still considerable margin.

Central banks are looking through current low headline inflation and appropriately remain focused on the outlook for core inflation. Along with the divergent growth outlook, monetary policy is on a divergent path too. We expect the Fed will soon be raising interest rates while the Bank of Japan and the ECB, along with the RBA, are continuing to ease. The Reserve Bank of New Zealand (RBNZ) is on hold for now, although we continue to believe higher interest rates may still be required.

The outlook for the major emerging economies has become similarly divergent. The trend slowdown in the Chinese economy is continuing but we still expect growth of close to 7% this year. India is undergoing an economic resurgence, but Russia and Brazil are both likely to be in recession this year.

We see global growth of 3.4% this year, the same level as 2014, although the mix is different with stronger growth in developed economies but lower growth among the emerging economies. Growth then accelerates to 3.7% in 2016 as the growth performance of the emerging economies improves.

Our key asset calls remain essentially the same as last quarter. 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 the 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 US hikes will only occur if growth remains reasonably robust. Solid growth will help underpin earnings and share prices given valuations are not overextended. The Fed rate hikes could cause a ‘reset’ in US shares, but we expect this to be a temporary setback and would represent a buying opportunity.

Tighter US monetary policy can be (but is not always) a trigger for bigger issues in emerging markets. This time around our expectation is for emerging markets to wobble but not collapse, given the expected modest nature of the US tightening cycle and the overall better shape of emerging markets with regards to currency regimes, international reserves and current account positions.


We expect the USD to continue to move higher on the back of US rate hikes, which implies further weakness in the NZD. Given the adjustment we have seen so far, however, the NZD could stay around these levels for some time before trending lower again. Finally, we think a modest improvement in global growth, together with large cuts in supply capex, is setting the scene for a recovery in commodity prices, but this may be a 2016 story.