As we approach the end of another year, it is typically the period to reflect on the past 12 months, so what better time for our clients to hear from their Fund Managers regarding the activity within the investment markets in 2015 and the outlook for 2016.
Through 2015, several key global developments have dominated the financial headlines and driven market sentiment.
Early in the year, fears that Greece would be forced out of the European monetary union (a 'Grexit') cast a shadow on the economic backdrop and weighed heavily on investor sentiment. The situation caused European equity markets to underperform at times, although asset markets rallied in relief after the Greek government eventually secured a longer-term extension to its bailout. Since then, markets have been able to put fears of a Grexit aside, while stimulus provided by the European Central Bank ('ECB') has further supported the European economic backdrop and improved investor confidence.
A second major concern for investors has been the timing of potential interest rate rises from the US Federal Reserve ('Fed'). The Fed's policymakers have continued to communicate a desire to normalise monetary policy from the highly accommodative stance that has been in place since the Global Financial Crisis. However, this has not tied in with the market's more pessimistic view on the US economy, which was underpinned by disappointing economic data in the first half of 2015 (although this was largely due to transitory factors such as poor weather and strike action at many key ports and trade centres). The slowdown in economic data had raised fears that the Fed might raise interest rates too early, thereby choking off the country's anaemic recovery.
Investors' expectations of an interest rate rise did eventually rise in the third quarter as we began to see clarity on the economic front. However, the Fed somewhat confused the market in September by presenting a dovish statement on policy, which it mainly attributed to heightened global uncertainty and increased market volatility. Its concerns largely stemmed from a third major source of event risk; namely, China.
The domestic Chinese A-Share Index had performed extremely strongly during the first half of the year, in line with a rise in unregulated equity margin financing. However, this trend had begun to reverse in the third quarter as China's regulators implemented several policies to crack down on such practices. A simultaneous softening of Chinese economic data, together with rather ham fisted policy responses (which included the People's Bank of China surprising the market with a sudden devaluation of the renminbi), caused market participants to worry that a deeper slowdown might be occurring within the country. This led to increased volatility in asset markets and culminated in the events of 'Black Monday' (24 August), where a number of major global equity markets suffered their largest single-day declines in many years.
So where does this leave us as 2016 approaches?
Our opinion is that investors can look through these concerns, provided they take a long-term view within their investment portfolios. Short-term issues, such as those we have discussed, often provide opportunities from which longer-term investors can benefit.
We believe that the Fed is close to implementing a first interest rate rise. However, more crucial than the first hike are the pace of monetary tightening thereafter and the terminal rate (the interest rate at which the Fed is deemed to have normalised interest rates). While the global economy continues to grow, it is our belief that its growth will be below the longer-term average. This, together with a continued undershoot of inflation in the near term, leads us to believe that interest rates will remain at depressed levels for some time. Furthermore, they are likely to peak at lower levels than in previous interest rate cycles. In any case, increases in interest rates are likely to be small, well signposted and accompanied by cautious forward guidance.
Elsewhere, we see scope for the accommodative stance of some central banks to broaden. In particular, the ECB and the Bank of Japan may increase their Quantitative Easing programmes. As a result of these expectations, we continue to judge the longer-term investing backdrop as favourable for risk assets, particularly in the developed world. However, we remain vigilant of short-term risks and are more cautious on the outlook for emerging market equities.
Discretionary Fund Manager Portfolios
Our clients' portfolios have remained resilient during this period of heightened volatility. For the year of 2015 the portfolios are predominantly positive, despite the underlying FTSE 100 being down around 10% in capital terms. There hasn't been much discrepancy between the different risk profiles in overall portfolio return, albeit with a higher degree of volatility during the year. The defensive nature of our portfolios has provided us with a good spring-board to be able to perform well in 2016 if markets rally whilst continuing to be fully diversified should any short-term corrections occur.