Greater volatility in equities and a tougher environment for the fixed income market will likely mean lower overall returns in 2015, Flanders told FE Trustnet recently, echoing the words of Janus Capital’s Bill Gross who recommended investors acknowledge the “good times are over”.
Despite, the gloomy words Flanders still favours risk assets and in particular the US, UK and Indian equity markets. She has a more tentative stance on Europe.
The US was the best performing developed market last year with the S&P 500 up more than 20 per cent following a 29.1 per cent gain in 2013 and a 10.16 per cent rise in 2012.
Performance of index in 2014
Source: FE Analytics
The US economy was shown to be growing at its fastest rate for 11 years in December following a revision in the numbers from the Bureau of Economic Analysis, revealing 5 per cent annualised growth in the third quarter of 2014.
The high valuations of US equities have led numerous industry commentators to maintain scepticism as to whether the market can hold up over the near future. However, Flanders, in a manner reminiscent of her former job as the BBC’s chief economics correspondent, is taking a more macro view.
She says the plummeting oil price, seen in the graph below, as well as the relative strength of the dollar could bode well for economies and markets.
Performance of indices over 6 months
Source: FE Analytics
“Like the fall in the oil price, an orderly rise in the greenback should be positive for markets and the global economy, helping to keep US monetary policy looser for longer while supporting a recovery in Japan and Europe.”
“But a more dramatic shift in the dollar’s value would pose graver risks for emerging markets and could threaten global financial stability if the US becomes the only game in town,” says Flanders.
“The yield on 10-year US government debt is now lower than it has been for well over 95 per cent of the days since 1964. Against that yardstick, equities still look relatively attractive; although the US earnings yield – the inverse of the price-earnings ratio – is also well below its historical average.”
“Even with short-term interest rates on the way up in Britain and the US, this is a lower for longer environment in which a modest overweight to risk assets makes sense. But at current valuations it is not an environment for dramatic double digit returns.”
IA North America was the best performing sector last year with the average fund up 18.52 per cent although a majority of funds returned less than the index.
Flanders also tips the UK second to the US as she says a “diverging” performance of the global economy favours the two markets.
She says the UK and the US are the only developed markets where the economy is encountering a ‘healthy’ amount of inflation.
The UK equity market was broadly flat last year, largely disappointing investors, following several years of steeply rising markets.
However, as a number of managers such as Neil Woodford and Mark Barnett have warned, the general election in May is a looming event for markets with the potential to ramp up volatility as well as cause a prolonged period of weakness following its results.
Performance of index in 2014
Source: FE Analytics
Flanders is also bullish on another top performing equity market last year: India, which she says will be a beneficiary of cheaper oil, although she is slightly more reticent than for the UK and the US.
The MSCI India gained 31.58 per cent in 2014 as sentiment exploded following the election of Narendra Modi on a reformist agenda.
To a lesser extent and Flanders says the outlook for Europe looks brighter this year than in 2014 for positive returns.
In fact European equities outperformed the UK but investor pessimism was notable, as a host of problems within the regional economy offset the expectation of quantitative easing from the European Central Bank.
Performance of index in 2014
Source: FE Analytics
In the past few days as the eurozone fell into deflation, markets appear to – at least in the short term –have stirred and headed up, albeit marginally.
Flanders says a potential turn in the credit cycle, a weaker euro, less austerity and greater economic reform and action form the ECB will help things along.
“We expect to see a modest uptick in the supply and demand for credit. This should be supportive of the broader economy. There is now a widespread expectation that large-scale official bond purchases – quantitative easing – will be announced in early 2015,” she said.
“With half of European corporate revenues coming from outside Europe, the weakness of the currency ought to feed through higher sales and profitability. Fiscal tightening started to ease off in 2014, after three years of government belt tightening, reducing the drag on the economy from spending cuts and tax rises.”
She concludes that ongoing structural reforms, as evidenced Spain and Italy, suggests progress is moving in the right direction.