The turbulent investment environment of 2015 has continued into the first part of 2016. Most global equity markets tumbled sharply from the start of January, suffering their worst ever start to a New Year.
The speed of the recovery from crisis conditions has since been breath taking, with the FTSE All Share index erasing its initial loss of more than 10 per cent to be in positive territory for the year (to 28 April 2016).
Supportive central bank policies have reduced the risk of a global growth recession created by the previously strong US dollar and a related collapse in global liquidity. The US Federal Reserve’s reluctance to raise interest rates again in the first part of 2016 was particularly helpful.
Performance of indices over 2016
Source: FE Analytics
The weakening US dollar has played a key role in improving the effectiveness of policy stimulus in China, supporting an improvement in global manufacturing from recessionary levels. Riskier asset classes such as equities and high yield bonds were previously priced to reflect the risk of recession and have rallied as that risk recedes.
It is quite logical that economically-sensitive stocks in the mining and industrials sectors have performed well as the growth outlook improves. Equity markets have consequently seen a sharp rotation towards value and recovery strategies. This is evident in the performance of UK equity funds, with SLI UK Equity Recovery, Schroder Recovery and UBS UK Equity Income leading the IA UK All Companies sector in YTD performance.
We are now at a key juncture that may determine funds’ performance for the rest of the year. Markets are already reflecting the lower risk of recession and many equity and credit sectors appear extended. Investors must judge whether the current recovery phase is sustainable or whether the global economy and equity markets will again be dragged down by structural impediments and worsening liquidity.
We believe the behaviour of the US central bank is key to the outlook.
Our base case is that they will struggle to raise rates meaningfully this year, or even over this economic cycle. Low productivity and high debt levels remain structural drags on economic growth. Moreover, we have already seen the destructive impact of US dollar strength and this acts as a significant constraint on monetary policy.
Therefore, we believe that US government bonds remain an attractive long-term holding, even though they will be volatile around changing inflation expectations.
If the Fed does keep interest rates low, we believe there is considerable opportunity for a more sustained cyclical recovery. The rebound in global manufacturing has barely started and should be supported by China’s significant monetary and fiscal stimulus packages.
This is an environment in which we expect significant further outperformance from value strategies and emerging markets.
We have increased our position in Legg Mason Royce US Small Cap Opportunity fund, a small-cap strategy that has struggled over recent years but is positioned to benefit from a recovery phase.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
After avoiding emerging markets for much of their downturn, we are also buying Brandes Emerging Markets Value fund as we believe it will participate strongly in any continued rebound from the region.
Elsewhere, we already hold Schroder European Alpha Income fund, which is biased towards value stocks.
The progress of the recovery will remain patchy and uncertain while economies deal with the spillovers from the recent crisis phase.
However, as long as the Federal Reserve is forced to relent from significant rate rises, we are likely to remain in an environment of cyclical economic recovery in which value strategies can deliver significant outperformance.
Mark Harris is head of multi-asset at City Financial. The views above are his own and should not be taken as investment advice.
