2015 looks set to be a year of contrast and volatility. Interest rate hikes in the US and UK will contrast with continued monetary easing in Europe and Japan. Headline inflation is declining and will, in some countries, turn negative. In contrast with the views of many market participants, however, we see this as a major positive which will boost real incomes, economic growth and corporate profitability.
Equities to deliver strong returns, but uncertainties remain
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We expect global equities to perform well in the first half of the year but struggle thereafter as the Fed begins to tighten and rising wages eat into corporate profit margins in the US and UK.
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The government that is likely to emerge after the UK General Election, and the policies that result, are highly unpredictable. This uncertainty is likely to cast a shadow over UK markets.
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European equities are likely to perform particularly well, as the ultra easy monetary policy of the European Central Bank (ECB) begins to revive the economy. The eurozone’s problems are far from being solved and the region is certainly not yet strong enough to withstand another global recession. Investors seem to be underweight the region and exceeding the market’s pessimistic expectations for growth and corporate earnings should be easy.
Emerging markets divergence
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Better growth and low inflation will help emerging markets, but rising US rates and a strong dollar are headwinds. As in 2014, we expect considerable divergence across emerging markets, with India and Indonesia likely to be amongst the strongest performers.
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China is important, not just as a market in itself but because it now has a powerful impact on the world economy. As the authorities implement widespread reforms and struggle to reduce the economy’s dependence on credit, growth is likely to remain sluggish.
Government bonds to struggle
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Where yields hit record lows across the world in 2014, government bonds are likely to perform badly in 2015.
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Signs of rising wage inflation are already evident in the UK and US, where unemployment has plummeted to low levels. Low headline inflation will not stay the hands of the Bank of England or the Fed if, as we expect, wage inflation continues to rise. Bond yields should rise in response, but judging how far and how fast will be difficult as we and the authorities attempt to gauge the scale of the inflationary pressures. This could lead to increased market volatility, not just in bonds, but across all asset classes.
Manage currency exposure
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Firm US growth and the prospect of rising rates point to broad-based dollar strength.
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As the ECB responds with aggressive monetary easing, the euro is likely to remain weak.
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The Japanese yen is also likely to remain weak and this may drag down other Asian currencies with it.
Overall, we expect equities to deliver the best returns in 2015, with Europe the strongest region. Government bonds will deliver plenty of investment opportunities but yields are likely to rise, especially in the UK and US. Investors should be careful to manage their currency exposure, as this can easily wipe out local market gains. Tightening by the US Fed will pose a challenge to markets but they will be raising rates in response to strong growth, pre-empting a rise in inflation. The overall investment climate remains positive.
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