8th December 2015
With the New Year fast approaching, Fidelity Solutions’ portfolio managers Eugene Philalithis and Nick Peters, look at which regions and asset classes offer the best potential, the headwinds and tailwinds for the global economy and the outlook for the FTSE 100…
Eugene Philalithis, portfolio manager at Fidelity Solutions, comments: “Overall, equities continue to be our asset class of choice for 2016. We remain in a stable growth, low inflation environment that favours equities, with the ECB and BoJ continuing their large scale QE programmes. However, given the potential for volatility around rate rises by the Fed and the pace of China’s economic slowdown, markets could be more volatile in 2016 than 2015. In this context, it is important to be diversified across asset classes, as this helps to mitigate key risks and can help deliver a less volatile portfolio.”
Which region do you favour for 2016?
Eugene Philalithis: “European equities benefit from a very supportive backdrop, as they continue to be underpinned by many of the same factors as in 2015. While the boost from low energy prices should start to fade, the continent will continue to benefit from loose monetary policy and a weak currency. As we head into 2016, the fiscal stance across the eurozone should become less of a drag than in previous years.
“Of course, equity markets within the eurozone offer a diverse range of opportunities. Investors may want to seek out equity markets on the periphery of the eurozone, which are at an earlier stage of the economic recovery and are more attractively valued on a P/E basis.”
Nick Peters, portfolio manager at Fidelity Solutions: “Japanese equities could be strong performers in 2016. Japan benefits from a broadly supportive backdrop of loose central bank policy and a weak currency. While the economy slipped back into recession in the third quarter, this should prove temporary, with the third quarter having also shown a pick-up in consumption.
“Even if economic growth does disappoint, Japanese equities stand to benefit from bottom-up drivers of growth. These include a friendlier shareholder culture, increased dividend payout ratios and increased equity allocation among government pension funds. As well as potentially being strong enough to overcome the impact of any economic weakness, these bottom up drivers of growth should help to narrow the historic gap in the Return on Equity (ROE) between Japanese and global equities. In the ten years through to 2013, for example, the ROE on the Topix averaged just over 6%, compared to 12.4% for the MSCI World Index.”
What could be the single biggest headwind/tailwind for the global economy in 2016?
Eugene Philalithis: “The biggest tailwind we could see in 2016 would be a general pick-up in global growth. Stronger growth would help to reassure investors around a number of risks and improve sentiment to equities in particular. Potential risks such as the impact of Fed rate rises would then prove easier to digest, as well as allaying concerns over the pace of China’s economic slowdown. In turn, this could help a rebound in Emerging Markets, although given the structural problems some countries face – such as Brazil – this would not result in a universally positive picture. Differentiation in EMs will remain important, both across countries and asset classes.
“The biggest headwind for the global economy would be inflation accelerating, leading to a faster than anticipated tightening cycle from the Fed. This could mean the Fed being forced to raise rates quicker than the US economy could cope with, as well as having consequences within financial markets.”
Where will the FTSE 100 end up in 2016?
Nick Peters: “Predicting an index is notoriously difficult, with any predictions either incorrect by the end of the year or right by blind luck. However, I still believe it’s a useful exercise as it helps us to think about the drivers behind equities and what we might see in the next twelve months.
“Overall, one can paint a relatively supportive picture. Wage growth is now outstripping inflation and is likely to continue doing so, given low levels of unemployment. This should help to support consumer demand, though this is admittedly more important for the more domestically focused FTSE 250. While sterling strength is a headwind for the economy, stronger growth in the eurozone (the UK’s biggest export market) could benefit the country.
“With the FTSE 100 having a high exposure (ca. 20%) to energy and commodity stocks, commodity prices will clearly have an important impact. Further declines (unlikely on balance) will clearly be a big drag on performance. However, should we see an appreciation in commodity prices, then the energy and commodity sectors could be big winners. Company management teams are now showing greater capital discipline and a propensity to channel free cash flow to dividend payments. As such, even if we just see a stabilisation in commodity prices, we could see an uplift in the energy and commodity sectors.
“However, the path for UK equities is by no means smooth. With Britain’s referendum on the EU due to be held by the end of 2017, there is a strong chance that this could be held next year. Referendums are unpredictable (see Scotland’s of 2014) and we are likely to see at least some market volatility. So although UK equities could do well, it could be a bumpier journey. For FTSE 100 investors, I think it’s more important to have active exposure which can selectively choose opportunities, rather than the broad index, which will simply be the average performance of good and bad companies combined. Overall, however, I see the index remaining relatively stable, finishing within 6,100-6,500.”