• Global equities not cheap but should continue to benefit from supportive backdrop
• Low commodity prices should provide boost to global economy
• Sentiment suggests equities can continue to climb the wall of worry in 2015
Looking ahead to the start of the New Year Paul Sedgwick, Chief Investment Officer of Frank Investments, gives his view on the 2015 economic outlook and the opportunities we can expect to see across the UK and global economies.
2014 Round Up
Reflecting on 2014 and as we look forward to 2015, mergers and acquisitions were one of the features of the past year. CEO's became more comfortable with the macro conditions and decided to take advantage of the cheap funding costs, buying revenue with the aim of increasing earnings through efficiency gains.
For the first time in years we enter 2015 with equity valuations looking slightly more stretched than they have done in the past few years.
The S&P 500 will close the year trading on approximately 16x earnings against a historic average of closer to 15x. On a price to sales basis US equities are more expensive than in 2007. Where equities do continue to look good value is against government bonds as almost half the S&P 500 offer yields superior to the US ten year treasury.
One of the reasons to be most optimistic for 2015 from an equity standpoint is the continued lack of positive sentiment to equities in general. Merrill Lynch continue to report that fund managers are holding higher levels of cash than the historic average, and retail investors appear to remain cautious, still bearing the bruises of 2007. Capital did flow into equities in 2014, but also continued to flow into bonds. The great and much anticipated switch from bonds into equities did not really occur as most of the capital that went into equities appeared to come from money market funds rather than taking money away from the bond market. Fund flow data indicates in 2014 $120 bn of capital went into equity funds, against over $200bn into bonds.
When we look ahead to 2015, one should never take anything for granted but the logical assumption is to expect 2015's macro outlook to remain fairly similar to 2014. The global economy is expected to grow between 3 and 3.5% this coming year, inflationary pressures should remain in check, helped in the short term by the fall in the oil price. Bond yields should therefore remain stable, with continued uncertainties governments and central banks are likely to continue to pursue pro-growth strategies.
The one big difference next year will be the anticipation that we will see the first interest rate rise in the US and the UK for over 5 years, and in contrast whether the ECB will end up buying government debt in full blown US style quantitative easing (QE). It is not beyond the realms of possibility neither happens, QE for Europe is politically difficult to say the least and the US economy although growing may continue to face headwinds from the rest of the world that will mean that there is no pressure to raise interest rates, the same may be said for the UK.
Once one comes to the conclusion that equities remain the asset of choice, sector allocation becomes the next decision. 2014 has been a year of the defensives outperforming the cyclical sectors, in particular as commodity prices have fallen sharply. Coming into 2015 one has to decide whether the strategy of remaining defensively positioned in the bond style proxy sectors, for example health and personal care and pharmaceuticals where valuations may be starting to look a little full or becoming more adventurous and look to the more cyclically based sectors, for example the materials and mining sector. The mining sector valuations remain attractive despite the fall in commodity prices, yields remain attractive and balance sheets are strong. Sentiment for the sector is also weak, we favour Rio over BHP Billiton for its quality of assets and lack of oil exposure.
Despite the strong performance in the pharma sector this year there are still opportunities to invest where valuations remain undemanding, with decent yields, and pipeline potential that could offer rewards for the long term investor. In HPC we favour P&G, a solid yield and the continuing move to streamline its portfolio should provide further upside in our opinion.
Defensives and technology have been the best performing sectors of 2014 and remain generally favoured to do so again in 2015 by most fund managers. Equity sentiment overall remains cautious going into 2015, encouraginly it does not feel like greed has fully taken over fear yet. The question will be: as lower commodity prices feeds into the overall global economy, will this increase demand and pricing power for raw materials, encouraging investors to move from the more defensive sectors. Not much panned out in 2014 the way most analysts expected and it is probable 2015 will be the same. Many risks still exist within the global economy, as we enter what some consider the 7th year of the bull market with questions being raised about how long it will last. One must remember historically a low inflationary environment with a supportive monetary policy has been positive for the equity investor, even if valuations do look a little stretched.