Morningstar's "Perspectives" series features investment insights from selected third-party contributors. Here, as part of Morningstar’s Guide to Financial Planning, J.P. Morgan Asset Management Chief Strategist for Europe Stephanie Flanders discusses four themes and three rules that matter most for ISA season.
Probably the biggest issue for global markets in 2015 is whether and when the US central bank will finally raise interest rates. With cheaper oil prices pushing down the headline US inflation rate, many in the markets think that long expected rate rise will happen later than previously expected. But the people making the decision in the Federal Reserve have always said they will base it on all of the available data – and most of the data coming out of the US economy today points in the direction of higher rates, especially the strength of the labour market.
On the other side of the Atlantic, the European central bank has made equally clear that it is going to loosen policy through large-scale purchases of sovereign bonds – quantitative easing. The message for investors? Interest rates are heading in different directions in the US and the Eurozone in 2015, even though inflation everywhere has been heading down.
The big new trends in the past 6 months are a stronger dollar and much weaker oil prices. On balance, I think both of these are positive for the global economy but they affect different sectors and countries differently and it’s important for investors to think through the consequences. The big positive from a lower oil price is that it puts money in consumers’ pockets to spend on other things and makes them feel richer. The positive from the stronger dollar is that it should make it easier for Europe and Japan to reflate their economies and grow their exports.
But a strong dollar does come with potential downsides for the US stock market and company profits – and obviously companies connected to the oil industry are going to be hurt by cheaper oil. Other things equal, you’d expect domestically-oriented US companies to be the big winners in this environment than those who are heavily dependent on foreign earnings. Likewise you’d expect big oil consuming economies in the emerging world to benefit relative oil exporters, or countries that have taken on a lot of dollar-denominated debt.
If you’re going to fish in emerging markets, it’s time to be even more careful in the way you do it. Most of the world’s economies benefit from falling oil prices, but it’s not a simply matter of piling money into countries that are net consumers of oil and taking it out of exporting ones. Also very important will be a country’s vulnerability to further strength in the US dollar, and how much it stands to benefit from higher consumption in Europe and the US. The bottom line is that you just can’t treat “emerging markets” as a single asset class any more. You have to dig deeper and be even more selective.
Bonds with longer maturities look well supported by the sheer strength of demand for these kinds of assets from institutional and retail investors and from non-economic buyers like central banks. In this unusual environment, you could even see yields head even lower – at least in Europe – and prices go up. But the market looks expensive by any historical metric, and the lower yields go, the worse the risk-reward trade off becomes. It makes sense to have exposure to core bonds as part of a balanced portfolio, but anyone looking for income from this part of the portfolio is going to need to cast their net a bit further than in the past.
Equities don’t look cheap either, in most of the major developed markets. But they look a lot better priced than core bonds, and with corporate bonds currently producing returns far below the returns from equity dividends, it’s worth thinking about balanced exposure to equities as a source of income.
But the Fundamental Rules for Investing Don’t Change
Take Diversification Seriously
We all know that a well-balanced portfolio can deliver higher returns at lower risk, but the market surprises of 2014 demonstrated this with brutal clarity. Bonds shocked market commentators and investors by soaring: after returning just 0.1% in 2013, government bonds generated over 8% in 2014. Long duration bonds, which most in the market had expected to do badly, were among the best performing assets out there, delivering returns up to 30%. The lesson is you need to allocate your portfolio on the basis of what might happen – not just what everyone expects to happen.
Don’t Try to Time the Market
We’re all human, so when the market slumps, it’s easy to make decisions based on emotion, rather than fact. But returns on the S+P 500 Index from the last 20 years show that six of the 10 best days in the stock market occurred within two weeks of the worst 10 days. If you sold US stocks after the market took a tumble in October 2014 your return for the year would have been just 2.4%. If you stayed in until the market dipped again in mid-December, your return was a much healthier 8.85%. But the last two weeks of 2014 were among the strongest of all for the US market. The annual return for investors who stuck it out to December 31st was nearly 14%.
Volatility is a Fact of Life in Financial Markets
In 2014, the Stoxx 600 had 34 days where there was more than a 1% positive or negative movement on the index. Going back to 1990, the average has been 67 days. We expect volatility to be higher in the next fewer than it has been recently, and market returns to be lower. The message is stay invested and realistic in your expectations for future returns.
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