Heightened volatility marked the first month of 2015. From equities to currencies and commodities, the effects of divergent global growth and monetary policy were felt across markets.
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Developed Markets Equities
Equity markets struggled to find a clear direction in January. In the first week of 2015, global equity markets were a sea of near-perfect red.1 Chief among investors’ concerns were lower oil (and its potential effect on energy company earnings and capital expenditure), the global growth outlook, and geopolitical issues in Europe, including the Greek election. But there were reasons for optimism as well.
In the US, for example, continued employment gains and rising consumer confidence supported continued acceleration in the world’s largest economy. The result: a volatile US market with 8 swings in excess of 1% in either direction (compare this to 38 for the entire year of 2014).2
Meanwhile, European equity prices3 enjoyed a lift off the back of the European Central Bank’s (ECB) announcement of a larger-than-expected asset purchase program. Even so, gains were tempered in the last week of January, as investors digested the election victory of the left-wing Syriza party in Greece. Signs of improvement in the euro zone economy were also supportive of equity prices. PMI data picked up alongside rising German confidence measures.4
Furthermore, loan demand increased and lending standards eased for the third consecutive quarter, both encouraging signs of thawing in credit markets.5 Overall, January was a solid month for European equities, returning approximately 6.7% in local currency terms.
In Japan, equity prices felt the tremors of the Greek election and some pressure from a strengthening yen. Japanese energy exploration companies also felt the pinch from lower oil prices. On the positive side, overseas shipments were strong in December, and the Bank of Japan maintained its pace of asset purchases at an annual pace of 80 trillion yen. By the end of the month, Japanese equities were up around 1.29% in local terms.6
We remain Overweight Developed Markets Equities. In the US, improving labour markets and lower oil prices should translate into increased consumption and growth, which should bode well for stocks, both large and smid cap. In Europe and Japan, accommodative monetary policy should create more liquid capital markets, helping to stimulate activity in the regions. Weakening of the euro and the yen versus the dollar should also increase demand for exports. Finally, UK equities warrant a closer look at current valuations. (See The UK equities landscape article in this issue).
Emerging Markets Equities
Emerging Markets (EM) Equities picked up in the second half of January.7 Emerging Asia equities yielded mostly positive returns, helped by lower oil prices. Meanwhile, Greece was the worst performing market on fears that a left-wing election victory could mean secession from the euro zone. Despite lower oil prices, sanctions, and a debt downgrade, Russian equities recovered some ground from end-of-2014 lows (partly due to the ECB’s quantitative easing policy announcement), and ended the month of January close to flat. Meanwhile, equity prices of its Eastern European neighbors, Hungary, Poland, and Czech Republic, experienced further declines during the month.8
We maintain a Neutral weight on Emerging Markets Equities. While tightening in the US may temporarily pressure EM equities, this should be offset by stronger external demand from developed markets, particularly from US consumers armed with a stronger dollar. Wide disparity in valuations bodes well for actively managed vehicles. Markets on the import side of the energy trade should outperform.
A better US economy is putting pressure on the Fed to raise rates
The mood at the start of this year was decidedly “risk off”: while equities suffered pullbacks, Treasuries came into favour. Heightened geopolitical risk and doubts about global growth have increased demand for safe-haven assets, pushing down US Treasury yields. In addition, the Fed has remained “patient” in its timeline for raising rates. Falling oil prices pushed down inflation expectations and long-term yields, but as oil prices rose in the past week, we saw some pressure come off.;
Improving US economic data, particularly in the labour market, is building the case for an increase in interest rates. Rising rates will hurt fixed income investors, especially those with passive, long-duration exposure. European sovereign bond yields fell further after the ECB’s announcement of its asset purchase plans, but yields in this space do not have much room to fall further. We remain either Underweight or Neutral fixed income assets for these reasons.
High Yield and Emerging Markets Bonds
Emerging Markets Bonds were down around 1% in January.9 With a stronger US dollar and a more volatile geopolitical landscape, yields do not seem to compensate for the additional risk.
We are Underweight Emerging Markets Bonds due to an unfavourable risk-return profile in light of geopolitical concerns, the potential for continued currency volatility, and impending tightening in the US.
US High Yield Bonds lagged US Investment Grade and US Government Bonds. Spreads on these bonds widened as investors fled risk assets and eschewed exposure to energy sector debt.10 We are Neutral on US High Yield Bonds. The higher coupons do not compensate for the risk of principal loss from widening spreads.
REITs kept their place as the best-performing asset class this month.11 REITs have benefited from lower-than-expected interest rates, which bolster the appeal of REIT dividends for yield hungry investors. Lower energy costs have given a lift to earnings in some sectors, such as hotel and retail REITS. Apartments REITs have been among the top performing sectors in recent months, but demand will need to outpace new construction for this outperformance to continue.12
We are Neutral on REITs. Despite strong fundamentals, the transition to a normalised interest rate environment could put downward pressure on prices.
Oil prices still under pressure but moderating
Oil prices stabilised in the second half of January, as US producers started to announce capital expenditure cuts. Industrial metal prices declined during the month. Copper, in particular, was hard hit due to softening demand from China. Meanwhile, precious metal prices rose, as investors fled to these perceived safety assets when equity markets pulled back.13
We are Underweight Commodities, as a stronger dollar, slowing global demand, and excess supply, in some sectors, will continue to put pressure on prices.
Alternative Trading Strategies
Our Overweight to most Alternative Trading Strategies is a hedge against anticipated variability in asset prices, as markets adjust to the decreased pace of US monetary stimulus and eventual rate increases. Global Macro funds and Managed Futures have benefitted from a pickup in volatility, particularly in the energy sector and currencies, since late 2014.14
Investing involves risk including loss of principal. International investing involves a greater degree of risk and increased volatility. These risks are magnified in emerging markets.
1 Based on returns for the first three trading days of 2014 from Bloomberg’s world equity monitor in local currency.
2 Source: Bloomberg, as of January 31, 2015. Based on S&P 500 Index.
3 Source: Bloomberg, as of January 31, 2015. European equities represented by Eurostoxx 50 Index.
4 Source: Bloomberg, as of January 31, 2015.
5 Source: European Central Bank, as of January 31, 2015.
6 Source: Bloomberg, as of January 31, 2015. Japanese equities represented by Nikkei 225 Index.
7 Source: Bloomberg, as of January 31, 2015. Emerging Markets Equities represented MSCI Emerging Markets Total Return Index.
8 Source: Bloomberg, as of January 31, 2015. Emerging Market country equity returns represented by MSCI Country Indices in USD terms.
9 JPMorgan, as of January 31, 2015. Emerging Markets Bonds represented by JP Morgan GBI-EM Total Return Diversified.
10 Source: Bloomberg, as of January 31, 2015. Government Bonds represented by Barclays US Treasury Index. Investment Grade Bonds represented by Barclays US Aggregate Corporate Index. ; US HighYield Bonds represented by Barclays US Corporate High Yield.
11 Source: Bloomberg, as of January 31, 2015. REITS represented by FTSE NAREIT US – ALL Equity REITs Index.
12 Source: Barclays, as of August 29, 2014.
13 Source: Bloomberg, as of January 31, 2015. Commodities represented by Bloomberg Commodity Index. Sub-sectors represented by Dow Jones Indices.
14 Source: Bloomberg. Returns as of September 30, 2014 for: Event Driven Strategies, Relative Value Strategies, and Managed Futures. Returns as of August 31, 2014 for Global Macro Strategies. Global Macro Strategies by Barclay Hedge Fund Global Macro Index; Relative Value Strategies by HFRI Relative Value Index; Event Driven Strategies by Dow Jones CS Event Driven Index.
Past performance does not guarantee future results. An investment cannot be made directly in a market index.