Webconference replay: Q4 2015 Market Insights (13 October 2015)Contributor JPMAM UK
We do think we are entering into a world where global monetary policy will diverge. We think there is a chance that central banks such as the ECB and Bank of Japan may loosen monetary policy further and a time when the US and UK are trying to raise interest rates eventually.
In her quarterly call to investors, Stephanie Flanders, Chief Market Strategist for the UK and Europe, discussed the following themes for Q4:
Will China and emerging markets sink the global recovery?
- Emerging economies are faced with three big challenges: slowing domestic demand, flat or falling world trade, and declining commodity prices. We should expect them to weather this triple storm with varied success.
- While these emerging market challenges will drag down global growth and inflation, we do not think they will derail the moderate economic recovery now underway in the developed world. But services and consumption are driving growth in these economies, not manufacturing or investment, which continue to be relatively subdued.
- Put it another way: it’s not just developed markets and emerging markets that are diverging – we also see services and manufacturing on quite different paths within developed economies.
Are we heading into a bear market?
- Corrections are normal and happen most years in equity markets – it’s partly to compensate for these market bumps that equities earn higher long-term returns. But historically, it has taken either a recession or extreme market valuations to trigger a true bear market, where equity prices fall by more than 20%.
- We do not see the ingredients for a recession in the developed markets in the near future. A recession caused by excessive central bank tightening, or a big rise in commodity prices, looks particularly unlikely given recent falls in inflation and commodity markets.
- Nor do we think extreme valuations are about to cause a problem – rather the opposite, given recent sell-offs. Standard valuation measures suggest that the US, Europe and the UK are all close to their long-term average values. The US S&P 500 is now a little below it.
Will the Fed or BoE ever raise rates?
- The Federal Reserve (Fed) likes to think it is being communicative, but that seems to have backfired in September, when it held off raising rates and communicated a lot of confusion about how policy would be decided in future.
- Having spoken repeatedly about raising rates before the end of the year, the Fed will need to have a good reason not to raise rates in December. It has found plenty of reasons to do so in the past and there’s no guarantee that it won’t find more.
- If the recovery in the US and Europe still looks decent in a few months’ time, we would expect the US and the UK central banks to raise rates within the next six months. But we do not think the UK can act alone. If the rest of the world is loosening and a US rate rise is put on hold, we’d expect the Bank of England to hold off in 2016, and any tightening of conditions in the UK to happen via the exchange rate.
- For investors, the pace of rate increases and long-term “neutral” policy rate are much more important than the exact start date. Both are likely to be much lower than in past cycles.
What should investors do?
- We see opportunities in the recent rise in credit spreads, especially in high yield, which we do not think is entirely justified. The fundamentals have deteriorated somewhat, especially in the energy sector, but not as much as some of these spreads imply. This suggests plenty of room for opportunistic investments in credit, at a time when sovereign yields are still extremely low. But selectivity is vital.
- With real wages picking up in the UK, and parts of the corporate sector now regaining their pricing power, it’s a good time to increase exposure to the consumer side of the economy. But you don’t achieve that by investing in the mega-cap global companies that make up the FTSE 100 and account for a large share of the UK component of the Eurostoxx. Small- to mid-cap stocks could offer greater upside potential in such a market, because they tend to source more of their revenue from domestic consumers.
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