As we come to the end of 2015, it may feel as if it were a year of turmoil, with volatility increasing, worries about the end of the liquidity cycle surfacing and the (surprisingly) sudden realisation by investors that Chinese growth cannot continue on a trajectory of 7% forever creating much soul searching. However, in terms of stock market moves, the year looks to be ending on a marginally negative note, with a muted decline from the peak of the Shanghai index in June. This makes predictions for 2016 all the more difficult. Nevertheless, there are some key factors a long-term investor can rely on:
Interest rates will rise from current levels, with the tightening starting in the US and followed in a staggered fashion by the UK and eventually Europe. This combined with reasonable economic growth in the US (the largest global economy) and in China (4-5% growth is still substantial for the second biggest global economy) should make for a constructive case for equities;
The world’s temperature has passed through the +1 degree level and looks set to go through the +2 degree level. Whatever decisions come out of the Climate Summit in Paris, future valuations of all assets have to adjust for a carbon discount;
The barbarity of the atrocity in Paris, which brought the kind of murder ISIL has been inflicting on Muslims in the Middle East for two years to developed economies, along with Russia’s adventurism in the Ukraine, underlines that political risk is likely to play a much larger role in investment thinking over the next decade than it did in the preceding decade.
Hermes Investment Management
As the tide recedes on market risk, sharp rocks are slowly being revealed. It will be possible to navigate around them, but only with careful portfolio management. Risk manifests itself in several different forms – no single metric will give a complete picture – but we can highlight a handful of areas of potential vulnerability:
Volatility has been on the rise and markets are likely to see further and more severe spikes in volatility in 2016;
Some decoupling between credit markets and equities has taken place and we expect that to continue, but the risk that correlations all rise together across asset classes is very real;
Liquidity risks remain most prevalent in the credit market, but there are genuine dangers of spillover to other markets in the event of financial stress; and lastly,
We expect markets to remain fragile and vulnerable to shocks.
Risk of contagion is on the rise and portfolios may appear more diversified than they actually are. Financial markets are inherently unstable and represent a challenge for even the fittest-for-purpose risk models – we must be aware of their limitations and the potential pitfalls into which our portfolios might be led.
Eoin Murray Head of the Investment Office
We are still expecting baby steps toward policy exits, as central banks with ‘skin in the game’ avoid taking the market off-guard. My outlook revolves around four beliefs. First, US and UK real policy rates will stay negative into 2017 and ‘peak’ rates will be much lower than we are used to. Eight years after the first traces of crisis, we have moved to a two-speed recovery. In the lead are the US, Canada, Australia, New Zealand and, for the first time, the UK. But in the slow lane are Japan, the eurozone and some emerging markets. The eurozone will continue to lack fiscal union. Greece may restructure, but this will likely be felt more by official institutions than private markets. And, like Japan, the European Central Bank (ECB) may
have to extend its liquidity. Second, lower peak rates could be delivered by the Federal Reserve and Bank of England selling some of the government bonds bought under quantitative easing (QE). A risk to the pound, though, is the ‘known unknown’ of the UK’s EU referendum.
Third, China is slowing, but has the ability to soften the landing. The effects on leverage and deflation need to be watched, but the Fed may not be knocked off course. Fourth, despite pockets of vulnerability, a blanket emerging market crisis seems unlikely. Few have fixed currency pegs to protect, so foreign exchange reserves need not be exhausted. Ultimately, they too may try QE.This all suggests that 2016 will be more like 2015 than 1994, when US rate hikes hit most assets hard. But, the policy ball is in China’s court.
Group Chief Economist
Seven years on from the onset of the global financial crisis, and our introduction to “unconventional monetary policy”, investors and savers alike are still waiting to return to business as usual. By now, it had been hoped that central bankers would have receded back into the shadows, rather than remaining centre stage. Market behaviour is still worryingly dependent on the latest utterance from the Fed, Bank of England or Bank of Japan (BoJ), something that appears unlikely to cease anytime soon.In 2014, the last round of QE came to an end in the US. An initial bout of “taper tantrums” was quickly reversed and global equity markets moved to fresh highs in the spring of this year, aided by the ECB and BoJ taking up the monetary easing baton. On the surface, all appeared calm. Yet, the end of QE in the US ushered in troubling times for other markets. Commodity prices tumbled, emerging market currencies cracked, credit spreads started to widen and global trade sagged. Even the mighty Chinese economy succumbed to the pressure, triggering a savage domestic bear market.
While the ECB and BoJ were pumping fresh liquidity into their economies, neither the Japanese yen or the euro were reserve currencies, and it was the effective withdrawal of US dollar liquidity that hit credit growth in many parts of the developing world. With the Fed still agonising over the first rate rise, despite an apparently healthy economy, volatility will remain an uncomfortable companion into 2016. While the markets are focused on the normalisation of interest rates, next year could well see the Fed return to the unconventional, with uncertain consequences for asset prices.
Head of Equities
Excerpts from Hermes Investment Management @AITbags