Investment Outlook

Investment Outlook fourth quarter 2015

02-10-2015

2015-10-02

“The only investors who shouldn’t diversify are those who are right 100% of the time”
John Templeton

Stock markets are back where they started at the beginning of the year after this disappointing quarter. The MSCI World Equity Index had a small positive return year-to-date expressed in Euro and a 6.6% loss in U.S. Dollar (USD). European indices are also at the same level. Starting the year we were most positive on U.S. equity markets, which showed the strongest economic fundamentals. Europe had several large uncertainties. During the first half year we reduced equity allocation slightly as valuations increased. Portfolios mainly benefitted from the stronger USD and Swiss Franc versus Euro as most return this year is coming from currency movements. Now that stock markets, after nine months, are back at January levels, it seems a good moment to evaluate which points remain valid from our earlier outlook. Each large economic region will be discussed separately below.


First the U.S., macroeconomic data remain strong. Consumers are confident, Purchasing Manager Indices are high and inflation remains low. Job creation is focussed on low range jobs and the job market participation rate remains low. Therefore economic growth is not likely to surprise on the upside of the current 2.5% consensus. This puts little pressure on the U.S. Federal Reserve Board (FED) to raise rates and historically the FED has never raised rates in a year that equity markets are down. If rates are increased, it should be happening gradually and equity markets should be able to sustain this. Financial markets have had time to prepare as the FED first mention of a less accommodative policy is already 2.5 years ago. Bond yields in the U.S. are undemanding because there is little likelihood of further yield decline there.


Secondly, Europe improved relatively to the start of the year. Political risks decreased with a Greek default being avoided, business confidence improving and at a post European crisis high, corporate profit outlooks are improving and loans of banks to corporations seem to be rising. At thirteen times price to earnings ratio, valuations have become more attractive. Due to the continued high unemployment and recent disappointing market movements the ECB can decide to broaden its quantitative easing (QE) program which should be beneficial for fixed income investments. QE has also proven to be beneficial to equity investments in recent years, resulting in high valuations.


Thirdly, although we were cautious about China, we underestimated the rippling effect lower economic growth had on global financial markets. In January we mentioned that real economic statistics were indicating a larger slowdown, but did not foresee this triggering a global sell-off, due to the low dependency of developed countries on China. The country only represents 5% of U.S. export. Finally, the portfolios have limited exposure in other emerging markets. Latin America has successfully been avoided and we continue to do so. We do remain constructive on Indonesia and re-evaluate Chinese equity at current valuations. Japanese corporate and social reforms seem to be underestimated and valuations in the region remain attractive at thirteen times price earnings ratio with expected continued double digit earnings growth.


Concluding, world economic growth is forecasted to remain close to 3% the coming years. With historic low/negative interest rates, neutral valuations in developed markets and low expected earnings growth we have reduced our average long term return expectations by 1% in our model portfolios. The Defensive portfolios are expected to return 3% the coming years, while the Balanced expected returns are reduced to 5% annually. Due to the large dependence on policy and the uprising of passive investment, volatility is likely to continue with high correlations between asset classes. The emissions scandal at Volkswagen and its effect on the entire car manufacturing sector and the German stock exchange even notably affecting index investors, once again show how direct stock selection, diversification and sector allocation can create value.


Asset Allocation
Equity allocations increased slightly over the last quarter. Downside protection through index put options was reduced. Reasonable relative valuations can be found in individual stocks that offer good and stable dividend yields with conservative balance sheets. Within fixed income we remain positioned for an appreciation of the USD and retain a higher duration in Euro denominated bonds than in USD bonds. Due to the risk reward and relative valuation, overall allocations to fixed income remain underweight. Platinum investments have been liquidated before the Volkswagen diesel fiasco, while maintaining investments in Gold & Palladium. Allocations in real estate are underweight and being maintained in high quality companies with limited loan-to-value ratios that should benefit from sustained low interest rates, urbanisation and investors looking for yield. The Laaken mandates currently have a relatively high percentage in liquidities, in order to keep overall risks lower and to maintain flexibility to respond in case of a possible further sell-off.

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