Investment Outlook

Investment Outlook first quarter 2015

06-01-2015

2015-01-06

“In matters of conscience, first thoughts are best. In matters of prudence, last thoughts are best.”
Robert Hall, 1943, Economist

2014 will be remembered as an impetuous investment year. Attained returns are markedly different for U.S. Dollar and Euro investors as the U.S. Dollar’s relative value increased nearly 14%. Financial markets went through a multitude of noteworthy events. First of all the world has sadly had to endure numerous violent episodes where our own country was also brutally confronted with the destructive violence of a distant war through the crashing of MH17. Secondly, the U.S. economy gained momentum even though the Federal Reserve Bank stopped further quantitative easing and it started the year disrupted by a polar vortex. Thirdly, U.S. banks increased their lending while the European economy muddled through and bank loans continued to decrease. Fourthly, oil prices have declined 50% to multi year lows leading to a large shift in the world economic situation. Finally, new leaders have successfully been installed in large emerging economies like Joko Widodo in Indonesia and Narendra Modi in India.
Looking forward, we agree with the consensus view that the U.S. is currently the best performing economy. Purchasing Manager Indices are indicating strength. Consumers, the motor of this economy, will have more to spend as the cost of firing up their own car engines decreased by about a third. The improved health and approval of government budget should further decrease any fiscal drag the coming year. If the economy remains this strong an interest rate rise can be expected. As long as possible higher interest rates are introduced gradually, motivated by strong economic performance and not by fear of inflation, we expect U.S. equities to continue their strong performance. The Dollar exposure of U.S. stocks should act as a cushion for Euro investors should rates rise.
Europe remains far less clear cut. We do not foresee that Europe will experience the same as what Japan found themselves in during the last two decades. The strength of the U.S. Dollar should help demand for export and increase corporate profits, but the U.S. is a relatively closed economy. We see significant downside risks. Political unwillingness to fundamental reforms in Greece, France and Italy could spark a remerging Euro crisis. The upcoming elections in Spain and the U.K. add to the uncertainty. Peripheral unemployment remains elevated and loans to corporations are not increasing. We see the poor state of the Russian economy as a risk that Putin might seek confrontation with more foreign regions to avert attention from a deteriorating internal situation.
China is going through an economic reform. Growth is expected to slow down in line with policy, yet remain close to 7%. Electricity production and railway statistics are indicating a larger slowdown. The recent opening of the Shanghai stock exchange to foreign investors is increasing the internationalization of the Chinese financial markets and should, in the longer term, bring more transparency. Currently earnings are expected to rise by an equal percentage in the U.S. and Europe as in Asia, but lower valuations can still be found in Asia. We remain invested in Japan as Abenomics can be further implemented after the successful re-election of Shinzo Abe. If the high expectations for both new leaders of India and Indonesia are attained, global growth could increase further. In Latin America the efficiency of the political policy remains uncertain.
Oil reached its lowest point in six years. The cause of the price decline is the main difference between the current situation and the last time the oil price was this low in 2009. Then, prices declined because demand evaporated. This time supply plays a major role with the U.S. ramping up supply by an additional million barrels per day in a year and the OPEC decided not to cut their production. For the global economy the current situation should be beneficial.


Asset Allocation
In an environment where various large regions can attain economic growth, input prices are low, margins are high and interest rates are low, equity valuations can remain elevated. We still see individual country equity index valuations as reasonable on a forward looking basis in developed markets and attractive in most emerging markets. The strong overweight in stocks of 2014 will be reduced, mainly by decreasing European positions, due to the aforementioned risks. We do not expect European interest rates to rise in the coming year and therefore prefer fixed income over equity in Europe.
In real estate we stay away from high leverage as these companies would have most trouble from an interest increase. With prices close to their marginal cost we continue to hold an allocation to precious metals for diversification purposes.
For our currency allocation we remain positioned for a further strengthening of the U.S. Dollar in 2015.

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