Geopolitical ructions eroded investor sentiment and led to a rocky road for investors this year, but what is in store for 2015?
Tilney Bestinvest chief investment officer Gareth Lewis says the year looks like one where investments will be strongly influenced once more by central bankers, with more political tension as well.
“[This year] the Scottish independence referendum set the cat amongst the pigeons and has focused investors increasingly on the political risks that lay ahead from an uncertain outcome in next May’s General Election and a potential referendum on the UK’s EU membership,” he explains.
This is still a banking crisis
The countries that were hit first by the credit crunch tsunami have recovered or are recuperating, but those further down the line have not yet begun to heal, Lewis says.
The US has largely recovered, the UK is a fair way along, but Europe and Asia are yet to be hit by the full brunt of the “rolling banking crisis”, he explains.
“Don’t be duped into thinking the banking crisis is over – far from it,” he adds.
“Loan loss provisioning within the eurozone remains inadequate and capital remains scarce. The fragility of the banking sector isn’t just confined to the struggling economies of the eurozone.
“There are growing concerns that much of the capital allocated to the China growth story has been misallocated and that could spur a wave of loan losses, that will see the epicentre of crisis move from the west to the east.”
The failure of the Fed
Unintended consequences of the great monetary policy experiment known as QE has damaged the recovery, Lewis argues.
QE3 was an unnecessary addition to the US Federal Reserve’s balance sheet that leaked trillions of dollars into the stockmarket that were used by corporate management to buy back massive amounts of shares, he says.
“Over $4trn was pumped into the system producing $1.5trn of economic activity. There was a vast amount of leakage, and you can see it’s gone to the stockmarket,” he explains.
“Low debt default rates have also prevented the expected increase in capital expenditure and investment that should normally drive economic activity. This suggests the corporate sector has become the main blockage in the monetary transmission mechanism.”
Expect eurozone QE – But rising eurozone funding rates
The European Central Bank is likely to roll out QE next year, which will help boost the ailing eurozone’s equities.
However, it is likely to make real interest rates rise as it is an “urban myth” that QE lowers bond yields, Lewis adds.
“It’s not true. The expectation of QE drives down yields, but the QE itself makes them rise because QE is pro-growth and pro-inflation.”
The US recovery was fuelled by its extraordinarily low interest rates, “fiscal forbearance” and a quickly recapitalised banking system, Lewis explains.
“Thus far, the eurozone has had none of these pre-conditions: the ECB has avoided implementing a politically-charged QE programme, fiscal policy has been tight and disjointed across the region and we believe the European banking system remains materially under-capitalised.”
The yuan is falling
The slowdown in China will lead to a “competitive devaluation” in the Middle Kingdom’s currency, Lewis predicts.
Money continues to flow to state-owned enterprises rather than the private sector, creating a “disjointed and increasingly unstable” economy, he says.
“The country’s excessive debt consumption linked to local government infrastructure investment is in danger of unravelling. The weak global economy and reduced competiveness suggests that authorities may be forced to devalue the yuan.”
Secular stagnation and ‘lowflation’
Oil prices slumping to $66 a barrel is just one symptom of the weaker global growth outlook, Lewis says.
“Secular stagnation” – when economies have negligible growth as a form of hangover from past debt splurges – is starting to manifest itself in many countries, he explains.
“While QE has increased the wealth of the few – increasing the developed world savings rate – this is to the detriment of investment.
“Only the inappropriate and excessive debt-fuelled Chinese investment cycle has kept world growth afloat. Weak commodity prices and the collapse in the price of oil are symptoms of this phenomenon.
That will lead to lower terminal interest rates, weak inflation and a prolonged bout of low bond yields, he adds.
Monetary stimulus is king
Central bank liquidity will be the driver of asset price growth rather than economic data, Lewis predicts.
The increasing divergence of monetary policy will be “key” to the direction of asset prices.
“QE cessation in the US, allied to modestly rising interest rates and high valuations, will prove a challenge for US equities.
“Japanese QE will continue to support equity prices. Eurozone QE is now widely discounted reducing the immediate impact, but – if linked with looser German fiscal policy – it could drive eurozone equities sharply higher.”
Just remember to hedge the currency, he warns.