There is no doubt that 2015 has been a difficult and frustrating year for most investors as macroeconomic trends have whipsawed markets and created plenty of volatility.
While there have been double-digit gains to be made from certain asset classes (Japanese and European equities, for example) headwinds such as China’s slowing growth, falling commodity prices, the Greek debt negotiations and the prospect of higher interest rates in the US have meant all major asset classes have posted significant drawdowns at points over the past 11 months or so.
Performance of sector and indices in 2015
Source: FE Analytics
Unfortunately, David Coombs – head of multi-asset investing – says this is a trend that is likely to continue going into 2016. 
“Markets are entering a year of great macroeconomic change that will buffet assets; however, strong, quality companies that deliver on their promises should fare well,” Coombs (pictured) said.
“We expect emerging markets will be less ‘safe’, as will illiquid asset classes, particularly high yield bonds. Political winds are whipping around the globe too. We think these could have a significant impact on investments, much more than they have had over the past decade.”
Here, the manager – who is comfortably outperforming his peer group composite over the longer term – highlights the four major themes that will dominate markets next year and how he is planning to navigate it within his portfolios.
Diverging monetary policy
First and foremost, he says 2016 will be an interesting year as for the first time since the financial crisis, central banks around the world won’t all be singing of the same hymn sheet with the US and UK likely to raise interest rates and Europe and Japan set to pump more QE into the market.
“‘Can-kicking’ by central banks has become an art form these days, but we are finally receiving some direction,” Coombs said.
“For once there is a healthy divergence of monetary policy between the US, UK, and everybody else. This will be a huge driver of markets over the next few years. It seems a near certainty that the US Federal Reserve will raise rates in December.”
“We are positioned for this by being overweight the US dollar, equities and macro hedge funds.”
Politics will dominate
The next (and slightly more concerning) theme surrounds politics, according to Coombs.
“Politics will matter again, and a lot. Broadly, investors are reluctant to talk ‘politics’, but policies and philosophies ultimately affect asset prices through fiscal and monetary actions,” Coombs said.
“In Europe, the popularity of anti-immigration parties, from both sides of the political spectrum, is spreading. This is significant because markets have been used to centralist governments. Europe still has several political skeletons in its closet: the Middle-Eastern refugee crisis and the partial closure of the Schengen agreement of free movement following the Paris attacks highlight the fragility of eurozone unity. “
“The continent is just too troublesome for our money right now, so we remain underweight.”
He adds that growing complacency in the UK and the future of the UK’s relationship with Europe could culminate in a lot of volatility for investors and is therefore largely avoiding the domestic market.
“In the UK, markets have written-off Labour leader Jeremy Corbyn as unelectable but this is dangerous, in our opinion. Labour’s performance during the Scottish and Welsh parliamentary elections, and the UK local elections, will provide the first yardsticks of Mr Corbyn’s sway.”
“If he does well, it could alter the UK’s investment narrative, meaning even greater volatility for UK assets. Volatility will only increase as we get closer to a referendum on British membership of the European Union and a possible ‘Brexit’. For these reasons we are underweight UK equities.”
There is also going to be a new ‘leader of the free world’ next year with the US presidential elections in November. While Coombs says this could create volatility, he remains overweight US equities given the country’s economic state.
Inflation will pick up
Coombs also believes that while it is extremely benign at the moment, inflation will start to pick up over the coming few months which could negatively affect swathes of investors.
“Recent falls in energy and fuel costs have detracted from the headline rate of inflation, in both the UK and the US, but we believe this will start to drop out from December,” he said.
Performance of indices since Jan 2014
Source: FE Analytics
“Inflation in non-core goods and services has been steadily rising for the last six months in the US, and it is stabilising in the UK. Further, labour market slack is disappearing, and productivity is showing signs of break-out.”
He points out that headline CPI inflation masks positive trend even in regions such as Japan, but admits that continental Europe is the major exception.
While Coombs isn’t expecting rampant inflation in the UK, he thinks it is right expect it to trend higher – which is one of the many reasons he is underweight fixed income.
“We think UK inflation will probably remain below the Bank of England’s 2 per cent target over the next three years due to low food prices, sluggish global demand, and scope for increased productivity to allow for wage growth.”
“However, the chances of the oil price rising next year are higher than the risk of further declines. The price is already depressed, and oil majors have slashed billions of dollars from cap-ex budgets.”
The hunt for high yield will end
The final trend, according to Coombs, is that investors will stop chasing yield and focus on high quality assets that generate a good and growing income.
“The crazy hunt for yield has also played out. Investors are now looking to invest in those companies that can offer earnings certainty, rather than just hyper levels of income. Instead of the mind-boggling returns from ‘the next big thing’, we think ‘boring’ companies are likely to outperform,” he said.
“They will be those large, well-capitalised and entrenched market leaders that can achieve returns through efficient cost controls, steady revenue growth and the ability to progress dividends. Many quality companies have been heavily sold down after moderating or cutting their expectations for next year. This might present significant opportunity.”
This is at odds with how many other market commentators think, given how well quality growth companies have performed relative to value stocks over the past few years
Performance of indices over 2yrs
Source: FE Analytics
“There is a risk that, having done so well, that – to use Nick Train’s terminology – these type of funds go to sleep for a while. I’m not suggesting that these is going to be some sort of cataclysm for these funds, but on the other side of that you have to think how badly value has done,” Premier’s Simon Evan-Cook told FE Trustnet last month.
However, Coombs thinks focusing on quality will be the best way for investors to protect themselves.
He added: “Stock market valuations corrected substantially over the summer, but the cushion for disappointment remains thin, with investors ready to dump companies that fail to hit their numbers or cannot offer earnings’ certainty.”
“We believe businesses with pricing power and more stable revenues offer the best protection in the current low-growth world.”
