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2015 Year End review

07 January 2016

Jonathan Marriott, Chief Investment Officer

In 2015 returns have been hard to come by and we have seen more volatility than direction in many equity markets as positive factors were eroded by a series of difficulties. In the early months of the year the European Central Bank (ECB) started to deliver on quantitative easing measures. Subsequently the Greek crisis took them to the brink of default before being resolved. This was followed by fears of slowing growth in China and a collapse in commodity prices. The surprise UK election result passed without significantly impacting investment. Economic data in the US generally improved, however the build up to the first rate rise weighed heavily on any positive sentiment. In the event, expectations of a rate rise had been managed to such an extent that the actuality had very little impact.

The rise of Islamic State, the refugee crisis and the tragic attacks in France have weighed more and more on sentiment as the year progressed. On the political front we have seen a rise of populist anti establishment parties in Europe. There is some evidence of this in the US with the rise in popularity of Donald Trump. Even Angela Merkel’s high ranking in German opinion polls has shown signs of wavering following her decision to allow refugees into Germany. The French and Spanish elections in December provided evidence of this with the rise of the National Front and Podemos political parties. In Spain it may be many weeks before a new coalition government can be agreed.

Equity markets have shown a wide dispersion of returns. The FTSE 100 index, which has a high commodity related component, ended the year down nearly 5% and, even taking dividends into account, fell over 1%. Meanwhile the FTSE 250 mid capitalisation index, which is more domestically focused, was up 11% when dividends are included. This has lead to pockets of better performance within difficult markets. Going forward we see more of this hence look for active managers and selective equity exposure to take advantage of such dispersion. It has been a record year for Mergers and Acquisitions with tie-ups between oil majors Royal Dutch Shell and BG Group and drug makers Pfizer and Allergan topping the headlines. However individual stocks have been hit by negative news such as the emissions scandal at Volkswagen. In Japan we have seen a growing emphasis on corporate governance and shareholder value but we have also seen Toshiba covering up losses in its nuclear business for many years.

The outlook for inflation and interest rates is a key factor for many investors when looking at the year ahead. The fall of headline UK inflation has been in the main attributed to moves in commodity prices. As commodity price falls in the last year begin to drop out of the ‘year-on-year’ equation, some pick up in the Consumer Price Inflation is expected. However, core inflation excluding the effects of energy prices has also been falling. There are fundamental long term effects in play that may keep average inflation low for a prolonged period of time. Where Central Banks have consumer price inflation as a specific target, this may mean that rate rises are muted and peak at a much lower level than in previous cycles. This path of interest rates has been predicted by the Bank of England for some time.

The growth of the internet from online shopping cutting out high street shops, Uber taking over from black cabs and AirBnB competing with hotels is providing alternatives to traditional suppliers and keeping prices low. Robotics means the use of labour in production is decreasing and is cutting costs. The ability to move production offshore to cheaper third world countries has increased through globalisation of markets and faster communication. We have not seen change on this scale since the industrial revolution. At that time mass production meant more was produced for less. While the situation is not identical there are parallels that can be drawn.

In the US, rates have started to rise for the first time since 2006. The Federal Reserve has carefully managed expectations to minimise the impact of rate rises. We expect further rises to be gradual and to peak at lower levels than previously. In the UK, the Bank of England has an explicit inflation target and we expect the Bank will be slower to act. If rates do not rise significantly then asset prices, particularly those with income attached, may continue to appreciate. While low inflation may not be good for earnings, equities may still perform positively as the earnings multiple expands.

The growing refugee crisis in Europe, the rise of populist right wing parties across Europe, depressed commodity prices and the US elections may provide plenty of reasons for increased volatility in the year ahead. In this environment, a selective approach to equity markets will be beneficial with a focus on companies that have secure earnings, are able to innovate or have niches where it is difficult for competitors to enter the market.