Looking back over 2015, Alan Higgins, CIO at Coutts reports that it was a year of contradictions and flat returns, punctuated by global growth fears and ending with a vote of confidence in economic recovery as US interest rates were lifted for the first time in nearly a decade.
Coutts looked for global equities to come out ahead of ‘safe-haven’ government bonds, which they did, but not by much but the firm reports there was a definite benefit from favouring European equities, as the Euro Stoxx index posted returns of 11 per cent compared to a modest gain of 2.6 per cent for the MSCI World index of developed markets.
Higgins writes: “Japan’s Nikkei 225 – another of our preferred markets at the start of 2015 and the only other major market to even come close to Europe – was also up 11 per cent on the year. On the other hand, falling commodity prices and fears of a China-led slowdown in global growth were especially bad news for high yield bonds and emerging equity markets, both of which we had exposure to over the course of 2015. We scaled back our position in emerging equities over the course of the year, but see high-yield bonds as oversold on fears of defaulting energy bonds.”
While there wasn’t much to choose between returns on equities and government bonds over the year, Higgins reports that diversification was king. “In theory, a diversified portfolio should generate higher returns with smaller losses than one with only a few correlated assets. But this has become harder to achieve as markets have become increasingly interconnected.”
Bonds remain the most important diversifier for an equity-rich portfolio, Higgins believes and notes that when equities crash, investors usually rush to the relative safety of bonds.
Europe remains popular with him and his team. “Europe's equity markets looked good to us at the start of last year – and they look even better now. In our view, price gains have lagged improvement in the corporate earnings outlook and Europe’s economy is on track to grow comfortably through 2016-17.
“Favourable factors at work include the European Central Bank's monetary stimulus, improving consumer demand and housing conditions, low energy prices (Europe is a big importer of energy) and a competitive currency. After being subdued for a year we expect the global manufacturing cycle to pick up over 2016.”
Coutts also believes that Europe's profit cycle is at a favourable stage. “Whereas company margins (the ratio of profits to sales) in the US have reached record highs and are now falling, in Europe they are low and rising. As we look ahead to the coming year, our preferred combination of improving economic growth and inexpensive equities is best met by Europe.”
Finally, turning to the FTSE 100, Higgins believes that it could come back to favour. “Over the past year the internationally biased FTSE 100 has lagged the more domestically focused FTSE 250. But given our positive outlook for the global economy in the year ahead, we see the best value in UK equities being among big multinational companies. These large UK companies are more attractively valued than their smaller UK and global peers. With an inflation-busting 4.5 per cent dividend yield, based on expectations for 2016, we think you are also getting paid well to own the FTSE 100. We see the FTSE 100 outperforming in 2016, as sentiment improves toward the global economy.”
