Russell Investments' 2015 Annual Outlook: Global "squeeze play" continues as central bankers embark on diverging paths
– Strategists ‘cautiously optimistic’ on global (and New Zealand) economic growth
– Team sees Asia-Pacific shares performing in line with other major regions
AUCKLAND, 19 January 2015 - Russell Investments has released its 2015 Annual Global Outlook report, which outlines key investment insights, economic forecasts and market predictions from the firm’s global team of investment strategists for 2015.
In the report, Russell's strategists explain how anticipated tightening from the U.S. Federal Reserve (Fed) and Bank of England, contrasted with expectations for easing from the European Central Bank (ECB) and Bank of Japan, will play a leading role in shaping the global capital markets through 2015.
"After shaping global economic and market realities the past five years, the major central banks appear headed in divergent directions in 2015," said Russell's Global Head of Investment Strategy, Andrew Pease. "The key question for investors to watch in 2015 is the amount of spare capacity in the U.S. economy. This will determine the amount of inflation pressure, the extent of Fed tightening, profit margins and long-term interest rates."
In the report, the strategists laid out their two main scenarios for the U.S. macro outlook. Their favored scenario is a continuation of single-digit profit growth, further gradual declines in unemployment, and a Fed that commences a gradual tightening process in mid-2015 with clear communication. In this scenario, U.S. 10-year Treasury yields rise beyond 3% and credit performs well – relative to Treasuries – with a backdrop of low default rates and subdued volatility.
The team outlines their scenarios in the larger context of a square-root shaped recovery for the U.S. economy, a forecast they have supported since 2009. For 2015, the strategists remain optimistic about economic growth, with expectations for stronger growth in all the developed economies such as real Gross Domestic Product (GDP) growth of 3.0% in the U.S. and 1% to 1.5% in the Eurozone over 2015.
"The U.S. market sets the tone for the global outlook and a key indicator to watch will be hourly earnings in monthly employment reports," added Pease. "This likely will provide investors with the first evidence that labor market conditions are tightening enough to hurt margins, push up inflation, and make the Fed more hawkish. Conversely, subdued wage growth will be evidence that our favored scenario is on track."
Regarding New Zealand and Australia specifically, Graham Harman, Russell's Sydney-based senior investment strategist, said, "New Zealand and Australia delivered impressive economic outcomes through the years of northern hemisphere crisis, but now face their own challenges, in turn, as a range of relevant commodity prices turn decisively down."
While Mr. Harman expects the New Zealand economy will slow a little in 2015, he sees real GDP growth as unlikely to drop much below 3%.
"Further official rate rises are in our view on hold for the time being, and New Zealand bond yields offer attractive premiums over both U.S. and Australian bonds, he added.
Regarding Australia specifically, he said, "Our fear is that the housing cycle will swing from up in 2014 to down as 2015 unfolds, and will reinforce the contractionary effects of a resources boom turned to bust. However, given support from a sharply weaker Australian dollar, and with the corporate sector in good shape, we foresee a slowdown from real growth of around 3% in 2014, to about 2% or thereabouts in 2015. The risk of full-blown recession is in our view low."
To determine their global outlook for 2015, Russell's strategists used their "cycle, value, sentiment" investment strategy process, based on a set of qualitative and quantitative inputs. Their current global market perspectives are as follows:
- Business Cycle: Cautious optimism in developed markets
U.S. economic growth is robust, with expectations in 2015 for average monthly payroll gains of 200,000 and U.S. inflation of 2.0%. Japan is already showing tentative signs of economic recovery and will further benefit from quantitative easing as well as the delay of next year’s consumption tax increase. Growth indicators in the Eurozone are mixed, but recovering corporate profits and additional ECB stimulus contribute to an optimistic growth outlook. The Emerging Markets, however, are challenged by falling commodity prices, financing pressure on current-account-deficit countries – such as Brazil and Turkey – from the rising U.S. dollar (USD), and an expectation of only 7.0% GDP in China over 2015.
- Valuation: U.S. is stretched while Japanese and European equities are neutral
U.S. equities are still the most expensive with a price-to-book value around 2.8 times and cyclically adjusted price-to-earnings ratio of over 21 times, per the U.S. large-cap Russell 1000® Index as of Dec. 12, 2014. Both Japanese and European equities are scored as neutral value. Equity valuations in the Emerging Markets are attractive, with the biggest price-to-book value discount relative to developed markets in 10 years.
- Sentiment: Developed markets maintain positive momentum, despite some contrarian signals
A larger number of signals are in overbought territory, yet momentum still acts as a positive driver for equity markets. The U.S., in particular, looks overbought on a range of short- and medium- term indicators, including measures of investor sentiment, some technical indicators, and positioning indicators. The Eurozone maintains positive price momentum even though short-term sentiment has increased. Sentiment in the major Asia-Pacific regional markets, perhaps with the exception of Australia, is upbeat, but prone to disappointment in the short term.
Updated regional exposure forecasts
The strategists also updated their forecasts across global regions and asset classes for 2015, including:
- Asia-Pacific: The team believes regional equities have run ahead of the fundamentals and may struggle to hold their gains over the next few months. In 2015, they expect Asia-Pacific equities to modestly outperform both bonds and cash, albeit with heightened volatility.
- North America: In their central scenario, the strategists maintain a preference for U.S. equities relative to fixed income, with an underweight position for U.S. aggregate fixed income exposures. Within the U.S. equity market, they have a modest large-cap preference over small-cap. By year-end 2015, the Russell 1000® Index target is 1,200. However, if labor participation continues to fall, the team expects a bearish scenario in which wage pressure builds, profit margins are squeezed by rising labor costs, and U.S. equity prices face downward pressure.
- Eurozone: Increasing profit margins and revenues are likely to boost earnings, which support the strategists' decision to adopt an average overweight position for Eurozone equities. Due to sector composition concerns, the team maintains a neutral position on UK equities.
- Emerging Markets: While valuations seem very attractive for emerging markets, the team is highly cautious of the business cycle. As a result, the strategists view emerging markets as a longer term value opportunity.
- Currency: There is a strong consensus behind a strengthening USD, but the team believes that the major gains have already been made since the yen is already at 45-year lows in real trade-weighted terms and the Eurozone has a large and growing current account surplus.
- Real Assets: The strategists expect demand for infrastructure to grow, finding listed infrastructure to be the most attractive. Real estate investment trusts, however, are exposed to rising interest rates, and commodities are seen to be expensive.
- Credit: In early 2015, the strategists have a slight preference for credit over government bonds, amid a backdrop of low default rates and subdued volatility.
"As high valuations persist, especially in the U.S., and yields remain low, due to historically unorthodox easing policies from global central banks, investors are faced with a challenge to achieve their real goals in a low-return world, often squeezing many to riskier assets," said Jeff Hussey, Russell's global chief investment officer. "A wide source of opportunities and a nimble process will be crucial to navigate the current investment landscape. 2015 looks to be a year when active investment choices will matter, which suits the use of actively managed globally diversified, multi-asset strategies to seek to achieve desired outcomes."
About Russell Investments
Russell Investments (Russell) is a global asset manager and one of only a few firms that offers actively managed multi-asset portfolios and services that include advice, investments and implementation. Russell stands with institutional investors, financial advisors and individuals working with their advisors—using the firm’s core capabilities that extend across capital market insights, manager research, portfolio construction, portfolio implementation and indexes to help each achieve their desired investment outcomes.
Russell has more than NZ$352.9 billion in assets under management (as of 30/09/2014) and works with over 2,500 institutional clients, independent distribution partners and individual investors globally. As a consultant to some of the largest pools of capital in the world, Russell has NZ$3 trillion in assets under advisement (as of 30/06/2014). It has four decades of experience researching and selecting investment managers and meets annually with more than 2,200 managers around the world. Russell traded more than $1.6 trillion in 2013 through its implementation services business. Russell also calculates approximately 700,000 benchmarks daily covering 98% of the investable market globally, including more than 80 countries and more than 10,000 securities. Approximately NZ$6.6 trillion in assets are benchmarked (as of 31/12/2013) to the Russell Indexes, which have provided investors with 30 years of smarter beta.
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