Outlook 2015: Strategies for today’s market
Our investment experts discuss equities, fixed income and equity valuations
In this video our investment experts tackle a number of questions: Among them, is it time to start investing in Europe? What effect will falling oil prices have on interest rates and what is the outlook for the economy?
From left: Alain Bergeron, Mackenzie Asset Allocation Team Lead, Steve Locke, Mackenzie Fixed Income Team Lead and Tony Elavia, Chief Investment Officer
Outlook 2015: Strategies for Today's Market
Our investment experts discuss equities, fixed income and equity valuations
Here are some of the questions you’ll find answered in this video:
- How could monetary policy play out in 2015?
- What are the notable risks to the outlook for global markets?
- What is the broad asset allocation call for the first quarter of 2015?
- Are US valuations stretched compared to Europe?
- Is the US dollar going to outperform its Canadian counterpart?
- How will falling crude oil prices affect fixed income assets?
- What should you look for in the high-yield space in 2015?
TONY ELAVIA: So let's talk about markets. 2014 has been a great year. People started off with a lot of trepidation as usual, but the markets have done well. In Canadian dollar terms, the US is up in the high teens. As we close the year, the Canadian market is in the low teens.
We'll obviously talk about our expectations for next year in a little while. But there's no question that valuations continue to be stretched. And we've been saying this for the last few quarters. Steve, before we get to that, can you tell us your thoughts on the fixed income markets?
STEVE LOCKE: I think we have to look at the performance this year as being somewhat anomalous, in that we did have lower inflation throughout the year, and globally, as you point out, and that's driven us to lower policy yields in places like Europe. While at the same time, we have a differentiated policy in the US with the end of quantitative easing through the last half of 2014. So certainly some different policy wins, but overall the direction for yields has been down.
And in 2014, duration, our interest rate risk, was rewarded, coming down by about 80 to 100 basis points in North America and a little bit more than that in Europe based on their policy. As we look into 2015, I think we should expect that – certainly – policy is going to be, again, a dominant theme for markets, particularly credit markets.
But we expect that corporate debt should outperform. So when we're looking at a high yield oriented portfolio, we'd expect to earn a coupon. And that currently would be somewhere in the 6% range for 2015.
TONY ELAVIA: So coming to currencies and asset allocation, Alain, can you tell us your thoughts on those two areas?
ALAIN BERGERON: So heading into 2015 and looking essentially at various factors and risks, in general, we think that people should be neutral across many dimensions where we see the most opportunities in 2015 to deviate from the neutral weights and currencies. Specifically, we're slightly bullish – the US versus the Canadian dollar – and moderately bullish – the US dollar versus the euro.
In terms of the Canadian dollar versus the US dollar, so when we put that view on in the global investment community last year, there was also a big valuation component. That's not there anymore since the currency has moved – since the Canadian dollar has depreciated. But the US macro and sentiment picture are still stronger for the US dollar.
And in addition, the recent oil price drop that we've seen, that puts pressure on the Canadian economy. What often economists call that as a terms of trade shock. And that means that the Canadian dollar – everything else equal – is likely to take the role of a shock absorber. And that means that – everything else equal – should put probability for the Canadian dollar to depreciate further versus the US dollar.
TONY ELAVIA: What can you tell us about regional weights that we would like to attach to the equity markets?
ALAIN BERGERON: I think right now we think the most appropriate is neutral. The one big thing that we're watching is the US versus Europe, because from a pure valuation, that's a big opportunity. The US equity markets are – from a long-term perspective – expensive relative to European equities.
But as we look in 2015, there's a high probability that it will be a good time. Some time, maybe it's in the summer, where we should put that overweight and underweight. Essentially, the situation in Europe may get worse before things start to get better. And so, of course, we realize that by waiting for things to start to turn a little bit, we'll miss the bottom. But from a risk adjusted perspective, this is when the odds are the greatest.
TONY ELAVIA: So we've had significant declines in the price of oil. It caused a lot of anxiety in some places and euphoria in others. How does that factor into the behavior of fixed income markets and your strategies?
STEVE LOCKE: Yeah. It impacts it in a number of ways in fixed income. Clearly, as you point out, the oil price shock that we've seen in late 2014 could be stimulative for some economies as we look into 2015. So that is an implication for inflation rates, which are going to drive policy rates.
So we think about the US as a great example of this. The decline in oil prices puts more spending power to the consumer base of the US economy, which is, of course, about 70% of US GDP, so potential for upside GDP growth for next year, as you mentioned.
But at the same time, it's likely to lower the inflation rate. When you look at headline inflation, the energy basket is a significant component. And that's probably going to come down.
We saw an episode like this in the late 1990s. So we may see that play out again in CPI. All that means is that the Fed may be a little later in raising its policy rate than expected.
There were some expectations that were being built in that the Fed could raise the Fed funds rate as early as March of 2015. But we think it's definitely more likely to be in the second half of the year – at the earliest, maybe June. So there's the implication for the yield curve in terms of how the policy rate moves forward.
In general, though, lower inflation for developed markets around the CPI calculation – including the lower energy price – is likely to provide some stimulus and lower inflation. So that means that yield curves are likely to be somewhat well-behaved as we go into 2015.
TONY ELAVIA: So if you get an upside in economic conditions, does that all go well for the high-yield markets?
STEVE LOCKE: In general, it does. There's going to obviously be some exceptions. Clearly, higher yield corporate issuers that have a link to oil and gas in their revenues are obviously going to feel some pressure. We've seen that pressure appear in the late third quarter, early fourth quarter, of 2014.
The basket of high-yield that's related to energy is significantly lagging the overall high-yield market at this point. That is also, though, opening up some valuation opportunities for high yield investors in that space. In fact, we have already seen some of those appear in some of the names that we follow in high yield energy.
On the other side of that, though, oil is actually an input cost to many production processes. And so lowering that input costs could lead to a little bit greater margin for some companies that produce goods based on oil.
So when we look at this, there's a mixed response for high-yield issuers. As we've indicated, over the course of 2014 – and we would look into 2015, increasingly, so you need to be selective within high-yield, both in terms of the credit and the position of the capital structure that you're taking on. So that continues to be a theme, but we, in general, like high-yield credit this year.
TONY ELAVIA: So let's summarize what we've been talking about. The year is coming to an end, and the equity markets clearly did much better than what people had expected. The dollar appreciation has been also a story during the year.
Quantitative easing has sort of stopped in the US. It tapered. There was a taper tantrum last year. It has stopped now.
The fixed income market seems to have weathered that quite well. We have had a significant decline in the price of oil this year. That, in general, should augur well.
So the set of upside surprises from these conditions is clearly a potential. There are the usual geopolitical risks – in terms of tension in the Middle East, tension in some of these Middle Eastern and other countries, like Russia – because of declining prices of oil leading to some instability.
We have talked about how valuations are getting stretched. They continue to get stretched for the third year in a row. But the general macroeconomic backdrop seems to be congenial to continued equity growth. So that's a reasonably optimistic perspective in terms of the capital market conditions for the next year.