After the 8.9% decline recorded in the MSCI World index in Quarter 3, on the fallout from China’s ‘Black Monday’ selloff in August, the 4th Quarter of 2015 started more promisingly with markets rallying strongly in October. China led the way with the Shanghai Composite up 10.8% following China’s sixth interest rate cut this year and anticipated Central Bank action elsewhere which encouraged buying of riskier assets despite ongoing global growth fears. However, volatility proved to be a major feature of the quarter; markets managed to stay in positive territory in November before retreating in December on concerns over further falls in oil and commodity prices and the considered reaction to the first US interest rate rise in over a decade.
|4th Quarter 2015,
% total return
|Calendar year 2015,
% total return
The overall return for the MSCI World was a 5.5% gain in Q4, in local currency terms, with the increase for the full year coming in at a more pedestrian 1.3%. Despite dramatic swings over the course of the year China was the standout winner amongst major markets advancing 15.9% over the quarter and 9.4% for 2015 overall. The UK market had a relatively disappointing year due to its high exposure to commodities and energy. However, these sectors are concentrated in the FTSE 100 which fell 1.3% over the year. The more domestically based FTSE 250 and FTSE Smaller Companies indices delivered far superior returns of 12% and 13% respectively.
We can see from the above table that exchange rates had a significant impact on the returns made by sterling investors; enhancing investments in the US market but being detrimental for European holdings. This serves as a further reminder of the importance of a well diversified portfolio and in a future blog we will look at the availability of hedged share classes for fund investors.
Key events of the quarter
The IMF (International Monetary Fund) reduced global growth forecasts to 3.1% for 2015 (from 3.3%) and 3.6% for 2016 (from 3.8%). This is the slowest pace since the financial crisis but mainly reflects China’s slowdown and the effects of weak commodity prices on some Emerging Markets while developed markets remain more resilient. In October China reduced interest rates by a further 0.25% to 4.35%, its 6th cut in a year.
At the end of November the IMF voted to include the Chinese renminbi as the 5th currency in its SDR (Special Drawing Rights) basket which indicates confidence in China’s reforms. The renminbi joins an elite group of reserve currencies alongside the dollar, euro, pound, and yen.
Oil prices continued to slide following the latest OPEC (Organisation of Petroleum Exporting Countries) meeting at which ministers failed to agree on output restrictions, the usual way of addressing oversupply, and actually scrapped its production ceiling. Oil prices have now more than halved in the past 18 months returning to the levels of the financial crisis. Brent crude, the global oil benchmark, touched a 7 year low of $36.33 on the 14th December, and has been the main contributor to the persistently low levels of inflation occurring in most developed markets.
The US Federal Reserve finally delivered the long awaited increase in the Federal funds rate, increasing it by 0.25% to a target range of 0.25-0.5%. Fed officials anticipate a series of rate increases over the coming year, with the median projection by the end of 2016 being 1.375%, which suggests four 25 bps increases in 2016.
In the UK the highlights of the Chancellor’s Autumn Statement were the cancellation of proposed cuts to family tax credits ‘due to an improvement in public finances’. George Osborne also announced plans for 400,000 new homes to ease the housing shortage and the introduction of an additional 3% stamp duty on buy to let properties and second homes with the aim of abating a potential bubble in the housing market. The OBR (Office for Budget Responsibility) confirmed its UK GDP forecasts of 2.4% for 2015, 2.4% for 2016 and 2.5% for 2017.
Economic trends and outlook around the globe
UK growth slowed to 0.4 % in the 3rd quarter, from 0.5% in the second quarter, as construction and manufacturing weakened. The rate was revised down from 0.5% as the important services sector, which represents over 70% of UK economic activity, grew more slowly than expected. The IMF reduced its GDP growth forecasts for the UK to 2.5% in 2015 and 2.2% in 2016.
Services are critical to growth as the manufacturing sector has made a negligible contribution in 2015. Manufacturing output fell 0.4% in October, month on month, hampered by weak global demand and sterling strength. The UK manufacturing PMI (Purchasing Managers’ Index) fell further in December, to the lowest level in three months following a slowdown in output and new order book growth.
The outlook for consumer spending seems more positive, particularly as the benefits of a low oil price feed through to household budgets. UK consumer confidence has remained positive for the entire year which has not happened since 1974. Unemployment has fallen to a 7 year low while wages are growing steadily. Retail sales were boosted in November as retailers launched Black Friday promotions.
The Bank of England kept interest rates at 0.5% citing falling oil prices and slow wage growth as influences. Monetary tightening appears to have moved to further out in 2016 or beyond. Inflation was revised down short term but is still expected to reach the 2% target by end 2017. CPI Inflation has remained close to zero over the period.
The United States
US growth slowed to 2.0% in Q3 vs 3.9% in Q2 largely due to a slowdown in inventory build-up by companies. US manufacturing output rose 0.4% month on month in October but the momentum was not sustained and the ISM manufacturing index has since fallen into contraction. The IMF currently expects US GDP growth of 2.6% for 2015 and 2.8% for 2016.
However, buoyant consumer spending and improvements in housing led the Fed to drop its previous warning about global financial and economic risks and flag a rate rise in December which duly materialised. Strong US jobs growth and a fall in unemployment supported its case, helping to revive inflation a little despite continued deflationary pressure from commodities and oil.
Nevertheless, the Fed indicated that the pace of tightening will be ‘gradual’ due to the lack of inflation and global growth uncertainties. The US dollar strengthened over the year making life difficult for exporters but providing extra returns for unhedged investors.
Euro area GDP increased by 0.3% in Q3 the tenth successive quarter of moderate expansion. However, the ECB (European Central Bank) downgraded its GDP growth estimates to 1.5% for 2015, 1.6% for 2016, and 1.7 % for 2017. This aligns with IMF forecasts.
ECB president Mario Draghi announced that the Eurozone QE programme will be extended to the end of March 2017 with monthly purchases held at Euro 60bn. Key interest rates of close to zero have kept the euro under pressure.
PMI readings for Europe in November surprised on the upside; Eurozone economic activity expanded at the fastest pace in four and a half years. This should be positive for corporate profits but ongoing worries over the migrant crisis, the financial stability of Greece and the risks of further terrorist attacks will continue to weigh on sentiment.
Japan’s GDP rose to 1% annualised for Q3 and +0.3% quarter on quarter, suggesting the country is no longer in technical recession. The IMF forecasts growth of 0.6% in 2015 followed by 1.0% for 2016. A weaker yen has helped corporate profits reach record levels and investors have been encouraged by signs that Prime Minister Abe’s corporate governance reforms are leading to improved shareholder returns.
Japan has similarities to the Eurozone; the Bank of Japan continues with quantitative easing and other policies which are supportive of growth. Wage growth could start to drive up inflation although a stronger yen against other Asian currencies remains a risk. Another ongoing concern is proximity to China which is Japan’s second largest import partner; Japan’s stock market tends to suffer when there is turbulence in China. However, China’s transition to a more consumer driven economy supplying a rapidly growing middle-class population is actually a great opportunity for Japan.
China had a roller coaster year but finished as one of the top performing stock markets of 2015. Chinese shares have staged a strong recovery from the summer sell-off after the Central Bank injected further liquidity into the economy and declared the correction was nearly over.
The National Bureau of Statistics confirmed China’s GDP grew by 6.9% year on year in the third quarter of 2015, assisted by better than expected service sector results. This beat expectations of 6.8% and is close to the government target of 7% for the year although there is some scepticism over the accuracy of the data at this stage. Manufacturing output continues to struggle though with industrial output falling for the fifth consecutive month in October. Services and consumption now account for over half of GDP for the first time in history and should provide some support to overall GDP growth. The IMF forecasts growth of 6.8% for 2015 and 6.3% for 2016.
Less demand from China and lower commodity prices have proved negative for Asia and other Emerging Markets. Many EMs, notably Brazil, have benefitted from cheap finance as a result of prolonged low interest rates in US and the threat of higher rates led to large capital outflows as investor confidence evaporated. The strength of the US dollar has also had a negative impact, increasing the outstanding debts of countries which borrowed in dollars.
Conclusions and prospects for stock markets
Despite a modest outlook for global growth this year the economic environment should be relatively supportive for equities versus other asset classes. This is particularly the case in Europe and Japan where low interest rate regimes might continue to depress their currencies and provide a boost to growth. Furthermore, many experts believe that valuations remain most attractive in these regions.
UK equities offer attractive yields, around 4% on the FTSE 100, but dividend cover has declined to a 20 year low. A number of major companies cut their dividends last year, including Tesco, Centrica, and Anglo American and there could be more to come, particularly if energy prices fail to recover. However, on the positive front, the lag effect of lower oil prices should feed through in lower costs for many industries and provide a fillip to consumer spending. An interest rate rise in the UK, if forthcoming, may not actually perceived as bad news since it suggests confidence that the economy is strong enough to support it.
As always there are events on the horizon which could produce bouts of volatility. In the UK Brexit vote will become a focus of much debate and opinion polls already suggest the outcome will be close. The deadline for the referendum is 2017 but it is believed David Cameron may favour June or September 2016, thus avoiding French and German elections in 2017.
Low levels of inflation have helped central banks maintain accommodative monetary policies, with the exception of the Federal Reserve, and there is scope for further growth in consumption as the low oil price keeps inflation low and real incomes buoyant. The US remains expensive on valuation grounds and the effect of rising interest rates on growth prospects will be closely observed. In 2016 we also have a US presidential election and uncertainty over the outcome could cause nervousness among investors.
The low oil price remains a concern for energy companies. It has fallen almost 70% since June 2014, touching $35pb, and many traders expect the market to remain oversupplied, particularly if exports from Iran rise following removal of sanctions relating to its nuclear programme. With the global economy subdued and overcapacity still evident a rapid bounce back seems unlikely. Meanwhile many commodities producers are cutting costs drastically to ensure their financial viability and survival.
Emerging Markets (EMs) have closely mirrored the performance of commodities so caution is needed when investing in them. While valuations look very cheap they will continue to be volatile and negatively affected by dollar strength and Chinese economic weakness. China’s growth outlook remains uncertain and others, including Russia and Brazil, are still suffering from exposure to oil and commodity sectors. However, there will be winners and India is set to overtake China as the world’s fastest growing major economy with IMF forecasting growth of 7.5% in 2016. It is a major beneficiary of low oil prices, has favourable demographics and is seeing strong growth in financial services, infrastructure and healthcare.
In conclusion, with significant divergence between the best and worse sectors set to continue carefully choosing the best fund managers to select stocks on your behalf is more important than ever. For example, a good active fund manager will seek out those companies which benefit from lower oil prices such as retail and leisure activities, travel and transport and automotive related business. So we would emphasize the importance of careful research before investing.
While developed markets may still offer a more stable outlook, investors with a long term horizon may wish to rebalance their asset allocation slightly towards areas which have performed badly and where valuations are starting to look interesting again. One way of doing this is to adopt a pound cost averaging strategy; drip feeding your money into the market via monthly savings or ad hoc top ups.
Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.