Market movements
Let’s start with a brief look back at last year: the scoreboard shows that the best-performing major market was Shanghai A-Shares, rising nearly 50%, most of which came in the last three months of the year in response to a weakening economy and central bank policy toward supporting financial assets. This made the point again that financial markets are largely about policy, and that in many cases, bad economics can equal good returns. Italian bonds returned over 24% in 2014, and German bunds did well, with a return of 15%. Both reflected the very sluggish economy in Europe. The S&P 500 in the United States rose almost 15% in the year, and the dollar rose 12.5% against other currencies, particularly the euro. Down at the bottom of the league (so to speak), the honours board was besmirched by the fall in oil, with Brent Crude dropping in price in 2014 by nearly 50%. The major stock market that fell the hardest was Greece, down 30%. The fall in the oil price had an impact on a number of markets with a heavy weighting to energy. For example, the FTSE 100 index was flat on the year. But had oil stocks been excluded, the rise would have been closer to 6% or 7%. The American high-yield market underperformed the stock market and investment grade because of its weighting to energy as well. So you could say the three biggest events of 2014 were the runaway market regarding Chinese equities; the strong dollar (really a reflection of the strong American economy), the declining trade balance, and on the other side, the action of central banks, such as the European Central Bank (ECB), to loosen policy; and the sell-off in oil.
As we enter 2015, most of those trends appear to remain in place. In China, the authorities continue to loosen monetary policy as the economy gets worse and the stock market rises. The dollar has started the year strong against most currencies, in particular the euro. On 5 January, we saw the euro trading below 1.20 for the first time in about eight years. The sell-off in oil continues, with Brent Crude now dropping to around USD$55. These will be important themes as we look at 2015. The fall in the oil price, on the good side, stimulates growth. On the bad side, it impacts the fortunes of the energy sector and the countries that depend heavily on energy for their fiscal revenue. The plus is slightly higher world growth than would have been the case otherwise, maybe by 0.25%. The downside is the material impact on inflation.
The ECB is stepping up preparations to alter the size, speed, and composition of policy in 2015
That brings us to the next point, which is Europe. Just last week, we saw that bank credits in Europe fell in November, which makes 30 consecutive months in a row where there’s been a decline. No wonder ECB governor Mario Draghi made comments last week that the central bank is stepping up preparations to alter the size, speed, and composition of policy in 2015. If you want a large, flashing sign saying, “We’re moving into sovereign QE as soon as we can”, you can hardly beat those comments. Unsurprisingly, this goes along with a weakening euro, but that is a tailwind rather than a headwind for European equities because of the importance of non-European earnings. So whereas 2014 and 2013 started with strong European earnings expectations and declined, it could be the other way around this year. European equities remain on our buying list. The events we’re looking forward to this week, considering the strong dollar, include notes from the Federal Reserve meeting on 16 & 17 December, which was when it changed its language about monetary policy and signalled that it will be raising rates in the first six months of the year. Market participants will pore over those notes. The rise in US rates will be a feature in the first half of 2015. Another feature will be the importance of politics. We are now facing a presidential election in Greece on 25 January; it is likely that the left-wing Syriza party will form part of a governing coalition. It appears at this stage that it will not be strong enough to gain an overall majority. Syriza has scared people quite a lot recently by talking about withdrawing Greece from the euro, but as it has come closer to power, the rhetoric has eased. Alexis Tsipras, the leader of Syriza, made a point last week of saying they’d expect the European Central Bank to include purchasing Greek bonds as part of any sovereign quantitative easing. Politics will have a big year in 2015, not least here in the UK, with the general election on 7 May now impossible to predict.
So where does that leave us from the point of view of near-term opportunity? The picture looks to show the US economy continuing to strengthen, the European economy continuing to be weak, and the Chinese authorities attempting to prop up financial assets. We expect to see earnings expectations for American companies rise. We expect earnings expectations to rise for companies in Japan and Europe, as well, even as their currencies weaken. And although we’ve turned the calendar, our policy remains broadly unchanged: we are pro-equity, pro-high-quality businesses, pro-dividend payers, and, in the fixed-income market, pro-quality in investment grade. And as for oil: it is down now over 50% from its peak, supporting consumption, supporting the airline sector. But it’s hurting others, such as countries heavily reliant on oil revenues for their budget balances. That will be a consistent theme for the first half of 2015, as will be the inevitable cutbacks in production.
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