FOR FINANCIAL ADVISORS ONLY
Last year’s outlook was titled ‘Rational Inexuberance’, and contained a relatively conservative forecast that global equity markets would produce a mid-to-high single-digit total return for 2014.
* “Irrational exuberance” is a phrase coined in December 1996 by the then US Federal Reserve Board Chairman, Alan Greenspan, speaking about financial market valuations. Investors interpreted this as a warning from Mr Greenspan that the US stock market might then have been overvalued, prompting a brief correction.
The global equity market return for 2014, as measured by the MSCI World Daily Net Total Return Index (in euros) was 19.5%. The same index in local currencies (i.e. not translated back to euros) rose only 9.8% in 2014, illustrating the significant (beneficial) effect last year to Euro-based investors of the stronger US dollar and sterling (the US$ strengthened by almost 12% versus the euro in 2014).
The medium-term outlook for global equities remains positive. This view is driven by the persuasive macro background, as follows:
Figure 1: Contribution to Global GDP Growth 2014-15
Source: IMF, DB Estimates
Figure 2: Davy US Economic & Business Cycle Indicator
Table 1: 10-year Sovereign Bond Yields
I know I sound like ‘The Boy Who Cried Wolf’, but we believe monies will flow from bond assets into potentially higher yielding assets such as equities and property.
Firstly, history suggests some caution following the recent good years. According to SG Cross Asset Research (Outlook 2015 report), since 1875 the S&P 500 (US stock market index) has never risen for seven calendar years in a row. 2014 was the sixth in a row since 2008, so not a promising historical context for 2015.
Secondly, valuations continued to move higher in 2014, so that today they are around the long-term average – the chart below illustrates the price-to-earnings ratio for global equities (MSCI World Index). You can see the 50% re-rating in equity valuations since late 2011.
Figure 3: MSCI World Index (F) P/E Ratio
Equity valuations could of course continue to increase, but it’s our view that we need reasonable earnings growth in 2015 to justify current levels. We remain constructive that global earnings can grow meaningfully in 2015 (high single digits), given our economic growth forecasts, but in our opinion, current valuations do not provide much of a safety net if there are some earnings disappointments during the year.
Thirdly, there are a number of known risks ahead of us in 2015, which, at the very least, could cause market setbacks and increased volatility. Downside risks include:
We can map the probability of these risks becoming reality and also their likely impact on financial markets in the chart below.
Figure 4: Impact/Probability of Risks
So history, valuations and potential risks conspire to make us more cautious about our 2015 outlook for global equities. We see a mid single-digit return from equities, but with the possibility of increased volatility, more setbacks and a 10%+ correction at some stage. But our medium-term outlook remains positive overall – we forecast a 15% to 20% total return in global equities from today by early 2017, as the longer-term positive factors kick in, indicating that market pullbacks should continue to be viewed as opportunities to add to equity holdings.
The big surprise of 2014 was the continuing decline in bond yields, particularly in the US and Europe. The BoAML Euro Over 5 Year Bond Index produced a return of 20.5% in 2014, confounding many forecasts, including our own, that bond yields would rise in 2014. Instead the German 10-year bond yield fell from 1.66% to 0.54% over the year, while the Irish 10 year bond ended the year yielding 1.25%. It seems incredible that Ireland, Spain and Italy can all borrow 10-year money today for less than the US. Weak growth in Europe and an increasing threat of deflation means the ECB is likely to keep interest rates extremely low for several years and also introduce stimulatory measures. These moves by the ECB suggest that bond yields in Europe will remain at very low levels for longer than previously anticipated, but with the yields so low we maintain our underweight stance.
Property continues to perform strongly, particularly in the UK and Ireland. We believe Irish commercial property returns for 2014 will exceed 20%, and will be high single-digit in 2015.
The bulk of the activity in the Irish sector was initially driven by international investors but more recently domestic institutional investors, including REITs and hotel operators, have become more active.
Note that the managed/balanced/diversified growth funds we manage currently have an overweight allocation to Commercial Property (Prescient Select Portfolio – The Managed Fund, Trilogy 2 and LOGIC).
For more information, call or email us to discuss your requirements or arrange a meeting.