Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, JP Morgan Asset management market strategists Stephanie Flanders, David Stubbs and Kerry Craig give their outlook for 2015.
Both the US Federal Reserve and the Bank of England will likely raise rates in 2015 as their recoveries mature, whilst feeble growth and the risk of deflation will continue to threaten Japan and Europe. We see this in the chart below which shows different market expectations for target rate policy rates. There are both risks and advantages to this divergence but, for investors, it will have three implications: a stronger US dollar, continued weakness in global commodity prices and looser monetary conditions globally than previously expected.
This is still a world that rewards risk takers
Although a stronger dollar will likely have an adverse impact on some regional equity markets, investors needn’t necessarily fear it, continued Flanders, as long as it remains reasonably orderly. A stronger dollar is a win-win situation for the global economy if it helps to sustain the US recovery and revives demand in the rest of the world. It becomes dangerous when it reflects a more dramatic divergence in the economic fortunes of the world’s most important economies.
If a stronger US currency attracts international capital to dollar assets, investors will worry about the impact on emerging market performance. However, emerging markets’ stronger FX reserve positions and greater exchange rate flexibility leave them better poised than in past cycles, suggesting they can avert any currency crisis.
While monetary policy will remain extraordinarily loose globally, the path to normalisation in 2015 will begin in earnest with an interest rate rise in the US, likely mid next year, assuming the US unemployment rate continues to fall faster than expected and wage growth picks up.
When the US Federal Reserve finally gets going it will increase the Fed funds rate by no more than a quarter of a percentage point in any one meeting to keep the move to monetary neutrality smooth. They may ultimately want to ensure long-term rates stay above short-term rates, implying negative total returns along the entire Treasury yield curve for maturities of two years and above over the course of 2015. Consequently, 2015 should be a year to be underweight Treasuries and short duration in the United States, although bond markets outside the US may fare better.
The 2015 outlook currently looks more promising for global equities than fixed income. Equity valuations still look reasonable by historical standards and in absolute terms. They also look attractive relative to inflation and interest rates.
The US will continue to lead the way, with earnings likely to grow at roughly mid-single digit pace in 2015. The macro picture is less clear cut for emerging market equities which remain hindered by the gradual slowing of Chinese growth, weakness among commodity producers, political drift away from free enterprise and the potential impact of higher US interest rates. However, Kelly argues that given a faster pace of economic growth, emerging market earnings should have strong long-term growth potential and valuations do not look extended.
The fundamental rule in investing that has applied over the past five years still applies to the investment environment as we enter 2015: when cash pays you nothing it is time to get invested in something. The bottom line is that this is still a world that rewards risk takers.
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