23rd December 2014
This year has seen an oil price slide, the collapse of the Russian stock market, and a continuation of the rally in core government bond yields.
With China’s debt mounting, global growth forecasts cut, and commodities in the doldrums, where should investors look for returns next year?
Below Legg Mason Global Asset Management and its subsidiaries have highlighted five asset classes they expect to perform strongly in the New Year.
Long-dated US Treasuries
Western Asset, which manages $470bn of fixed income assets, expects long-dated US Treasuries to enjoy solid gains in 2015, despite the yield compression already seen this year.
Yields have come in from above 4% on the 30-year Treasury to 2.75%*, but Western Asset says this is the area of the yield curve offering investors the best value as we head into the New Year.
“Long-dated US Treasury bonds will benefit from the dis-inflationary environment that we expect in 2015,” Western said.
“The combination of a stronger US dollar, lower oil price, and muted wage growth will continue to put downward pressure on inflation. The prospect of muted inflation, with the risks tilted towards inflation moving even further below the Fed’s target, will continue to keep bond yields low.”
Emerging Market debt
Emerging markets have been one of the most volatile areas for investors to negotiate this year, but also one of the most successful trades, outstripping many other bonds.
Both US dollar-denominated and local currency debt have enjoyed a positive 2014, although sharp falls in the last month have taken the edge off the overall return.
Brandywine Global expects EM debt to provide the most attractive value of all bond markets in 2015, with the latest falls providing an ideal entry point
“EM currencies and bond yields, especially in countries needing to finance persistent current account deficits like Brazil, Indonesia, India and South Africa, now offer elevated risk premia because investors are fearful of slowing global growth and a potential repeat of past crises.
“But EM fundamentals and global monetary policy conditions are different in the current cycle. In past EM routs, G3 central bank tightening decreased demand for higher-yielding EM assets.
“In the current cycle, because the 2008 deleveraging cycle was so powerful, we believe G3 rate hikes will be gradual, and will end with rates at very low levels, ultimately making higher yields in EMs too attractive for markets to dismiss.”
The Nikkei has risen 10% year-to-date in 2014*, with the US the only advanced market to outperform Japan. But with Japan experiencing the best earnings and dividend growth in the developed world, Legg Mason subsidiary ClearBridge Investments expects more of the same in 2015.
“While scepticism about the efficacy of the country’s aggressive stimulus program is well deserved, we believe it ignores real change in company governance toward creating shareholder value.
“This fundamental improvement has yet to be discounted in share prices, with valuations remaining among the lowest in the world. We believe low expectations for improvements in profitability and growth set the scene for continued upside surprises.”
Martin Currie, Legg Mason’s recently acquired subsidiary, expects European equities to bounce back in 2015, with the impact of quantitative easing on the region’s potential under-estimated.
“The disadvantages, pain and political impact of Europe’s struggle to reform its economies and cost structure are well known. What’s less appreciated — and likely not yet reflected in share prices — is the potential advantages that may accrue to companies doing business in that same environment.
“The combination of rampant unemployment and the mobility of labour within the EU have had the effect of driving labour costs down in parts of peripheral Europe, to the dismay of many, but to the advantage of employers trying to compete in a difficult global economy.
“If you then include the potential benefit of a more open-handed European Central Bank, as well as the heavily promoted €300bn ($374bn) infrastructure fund and the declining euro, it could add up to a solid year for select European companies.”
US small caps
While the largest US companies enjoyed a purple patch in 2014, small caps have had a much more mixed ride.
The Russell 2000 index is only up 4%* year-to-date, and only moved back into positive territory in the last few weeks of the year having experienced its biggest correction for three years in the third quarter.
The sharp sell-off has created opportunities for investors, according to Legg Mason subsidiary Royce & Associates.
“A closer look inside the small-cap index reveals that 49% of its constituents were down at least 20% from their respective 52-week highs as of the end of September.
“Meanwhile, more than one in ten are off more than 30% over the last 12 months. To us, this shows the correction has been rotational — it has been going on, quietly, for a long time. Our examination of the index suggested that the rotation has left many high-quality small-cap stocks undervalued.”