A survey carried out by Extel and Absolute Strategy Research quizzed a range of fund management groups, predominantly based across Europe and the US and with combined assets under management of £1.6trn, on where they expect markets to go in 2015.
The research found a net 79 per cent of respondents believe equities are set to rise higher than bonds in 2015, giving this an implied probability of at least 75 per cent.
This expected outperformance is surprising, given that 56 per cent of the fund managers polled think that stocks look expensive. Just 10 per cent consider them to be cheap.
Furthermore, only 28 per cent expect companies will achieve double-digit earnings growth in 2015. This means the outperformance of stocks is expected to come from higher valuations and/or weaker bond returns, rather than an improvement in fundamentals.
Stock markets have faced a challenging 2014. Although the S&P 500 has risen around 20 per cent over the year to date, in sterling terms, other major indices are much further behind.
To 19 December, the FTSE 100 was up just 0.40 per cent, the Nikkei 225 1.03 per cent and the MSCI Emerging Markets index 2.17 per cent. The Euro Stoxx had fallen 1.46 per cent.
Performance of indices over 2014
Source: FE Analytics
Looking to next year, a net 70 per cent of fund managers think stocks will end the year higher than their starting points, while just 11 per cent believe this is unlikely.
Mark Burgess (pictured), chief investment officer of Threadneedle Investments, remains constructive on equities over core government bonds. However, he is less optimistic than he used to be, given the “recovery-less recovery” playing out in the global economy and the risk this could hold back corporate earnings.
“For us to increase equity exposure at current levels, we would either need to see valuations cheapen a little, or have greater clarity on the earnings outlook for 2015,” he said.
Mathieu L’Hoir, Ombretta Signori, Gregory Venizelos and Franz Wenzel, analysts at AXA Investment Managers, said: “With global equities at all-time highs, it is only fair to raise the question of whether this cycle offers more headroom for risky assets. We think the answer is yes.”
However, they added: “October's sharp stock market correction was an unpleasant reminder that volatility is simply dormant. It will most likely raise its ugly head in 2015 as central bank policies diverge, rendering the directional call more challenging and requiring a more active management stance.”
While the Extel/Absolute Strategy Research poll found confidence in stocks to outperform, there was no clear consensus on what investors should be owning.
Regionally, a net 13 per cent expressed a preference for emerging market equities while a balance of 11 per cent said they are staying away emerging market equities. Technology was the most preferred sector with oil and basic resources sharing the least preferred spot.
Further lack of consensus can be seen how close the split is between fund managers’ view on more general equity market issues. They give a 52 per cent likelihood of small cap outperforming large cap; a 56 per cent likelihood of a value style outperforming growth; and a 59 per cent likelihood of cyclical stocks outperforming defensives.
Thomas Becket (pictured), chief investment officer at Psigma Investment Management, said: “We feel very strongly that investors need to start being far more selective, with regards to their investments, both by region and by sector. The performance of markets has become increasingly polarised this year, meaning that as we start 2015 there is a real mixture of expensive and cheap investments.”
Becket says the UK is more attractive than the US on valuations, while markets such as Japan, Europe and some emerging markets offer more recovery potential than the US at more attractive prices.
When it comes to fixed income, a net 65 per cent of fund managers surveyed expect 10-year US treasury yields to end 2015 higher than their current 2.18 per cent. The research gave this a 70 per cent chance of happening.
Bond yields are expected to rise next year if the Federal Reserve starts to lift interest rates, although the timing of when this will occur is still unclear. The Fed recently said it would exercise “patience” when considering increasing rates, a change from its usual reference of waiting “considerable time”.
John Higgins, chief markets economist at Capital Economics, said: “We expect the onset of Fed tightening to drive the yield of 10-year US treasuries significantly higher. Not only do we think that it will trigger an increase in the portion of the yield that captures investors’ expectations for interest rates, but we also suspect that it will cause a rebound in the residual ‘term premium’, which has collapsed in 2014.”
“By contrast, we are much less pessimistic about the prospects for 10-year government bonds in Germany and Japan. This is largely because we expect the monetary policies of the ECB and the BoJ to become looser, even as that of the Fed becomes tighter.”
Fund managers’ highest conviction in fixed income was that corporate bond returns will outpace sovereign bond returns, with a net 51 per cent thinking this will happen and giving it a 62 per cent probability.
The likelihood of inflation-linked bonds outperforming conventional bonds was given a 47 per cent probability. Linkers have performed strongly over 2014.
Performance of sectors in 2014
Source: FE Analytics
Jim Leaviss, head of retail fixed interest for M&G, said: “As the experience of the past few years has aptly demonstrated, making bold predictions for bond markets for the coming year requires no small measure of bravery.”
“Nevertheless, with substantial volumes of QE still on the horizon in a number of globally significant economies such as Japan and the eurozone, the prospect of deflation rather than inflation keeping central bankers awake at night, and the timing of interest rate hikes being pushed out in nearly all economies, it does not need a huge leap of faith to say that conditions for bond investors currently look relatively benign.”
“Equally, as the start to 2014 showed, all it takes is a few stormy months – literally or figuratively – for all best estimates to fall by the wayside.”
The survey found that equities will be the preferred asset class among fund managers in 2015, followed by real estate. Government bonds are the least preferred, followed by commodities and corporate bonds.
John Wyn-Evans, head of investment strategy at Investec Wealth & Investment, said: “We believe that a traditional balanced portfolio of gilts and equities is pretty much condemned to unexciting – but still positive – returns from current valuations.”
“One option in this environment is to take more risk not only by investing in more equities, but also by considering higher-yielding corporate bonds, real estate and infrastructure funds. The price to be paid for the higher return will be higher volatility, a factor that we shall have to get used to after several years of low volatility and limited market setbacks.”
