By Nick Skimming
Global equities have made decent progress thus far in 2015, with many of the major equity indices making new historic highs in local currency terms during the first quarter at least. The main driver has been policy action, with the ECB announcing a larger than expected QE programme, further stimulus measures in China and a four month extension to the Greek bail-out programme.
The European equity markets have been one of the clear winners so far this year after a strong multiple driven rally on the back of QE and some more positive indications of a turn in growth. The US market has lagged in local currency terms, with a stronger dollar weighing on profits at multinational companies.
Despite a growing consensus that the major government bond markets offer little value, yields fell in the first few months of the year, particularly in Europe, on the back of the ECB implementing QE. More recently, there has been a sharp selloff in May with the 10-year German Bund yield peaking at 0.72% and ending the month at 0.54%, after previously hitting a historic low. Clearly volatility has picked up dramatically as the spotlight on Greece casts a shadow over the nascent recovery in Europe, whilst volatility has also been driven by the continued uncertainty over the timing of the Fed’s first interest rates increase. Sovereign bonds have been weakest, whilst better returns have been seen from the High Yield space. The weakness in the Sovereign space may well provide opportunities, as little value has been seen here for some time.
The key themes in the currency markets over the year so far has been the continued strength in the US dollar, buoyed by the increasing divergence in monetary policy, particularly with the ECB finally implementing sovereign bond QE. Sterling has seen a rebound following the surprise Conservative Party win in the UK elections, which beat even the most optimistic of pre-election outcomes, whilst in the Emerging Market space there was a relatively wide divergence in performance. While the Russian ruble rebounded strongly off its lows, the Brazilian real declined sharply on increasing economic concerns.
The global economy is expected to deliver reasonable growth for the remainder of 2015 with the improvement being driven by the developed markets although the growth rate remains higher in some Emerging Markets. Growth expectations are further supported by the lower oil prices. Recent US data has been weaker, likely reflecting temporary factors such as the severe weather and port strikes on the West coast. We expect the US economy to continue delivering reasonable growth, but there may be some downside revision to the current consensus forecasts.
The euro area economy is recovering despite the many twists and turns in the Greek saga. Further monetary stimulus, a weaker exchange rate, stronger asset prices, a lower oil price and improved confidence are spurring better economic news from Europe. An adverse outcome of a Greek default would certainly be a negative shock to the region but will be mitigated by improving economic fundamentals regionally and the ECB’s QE programme.
Macro conditions in Emerging Markets are diverse. Chinese growth will continue to slow but we expect substantial monetary easing by the People’s Bank of China to soften the fall. The prospects for India are for an acceleration in growth with the low oil price being a major benefit as inflation trends lower along with structural reforms. Modi’s government’s first full budget struck a fine balance between fiscal discipline and supporting the cyclical economic recovery. We expect further interest rate cuts from the Reserve Bank of India.
If our views on growth are correct, then global inflation is likely to bottom sometime around Q2 or 3 of this year and then start to rise gradually. We expect the oil price to remain under pressure in the first half, reflecting the current over supply. However, as production is cut and demand increases we see the oil market moving towards balance. We expect a slightly firmer oil price in the second half of this year, which will result in some upward pressure on inflation. This should alleviate deflationary concerns. Low inflation will help sustain loose monetary policy on a global basis even if US interest rates move gradually higher. We expect the Federal Reserve to increase interest rates in the second or third quarter.
Nick Skiming is a portfolio manager at Ashburton Investments
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