Further reading |
|
The two key surprises of 2014 were the relief from interest-rate pressures as the US economy accelerated and the Fed ended bond purchases, and the 45% drop in crude oil, in the absence of major new fundamental developments.
In hindsight, the historically steep US yield curve and record yield premium on long-term US treasuries (compared to other safe-haven bond markets) made a US bond rally likely. High-quality sovereign yields don’t typically diverge as much as they currently have. In essence, the surprise is the 10-year German Bund yield of 63 basis points, a yield we might more easily associate with Japan.
Crude oil is even more interesting. US crude oil production has risen at a double-digit pace for three years now. Global crude oil demand has done nothing but grow mildly throughout. The disruptions or potential disruptions from security issues and political turmoil around the world were significant, and had the market’s attention in the first half 2014. But the US supply surge was always going to generate a major dislocation at some point.
Why exactly the oil price drop was so abrupt and not gradual poses interesting questions. The price decline just realized will drive major performance differences among oil consumers and producers in the coming year.
The financial distress of oil producers is actually a broader risk to market stability, even as cheap oil boosts real consumer incomes. But while few seem to see it this way, the immediate price drop is also likely to ensure petroleum’s long-term survival as a primary energy source.
We expect the US and UK to lead developed country growth in 2015, with the US outlook more assured amid political uncertainty in the UK. Real GDP in both are expected up 3.0%.
We expect Asia to be the region that benefits most from 2014’s oil price drop. The largest economies in Asia – China, Japan and India – have net import deficits in petroleum and petroleum products ranging from -2.5% to -6.0% of GDP, so an oil price drop is a very substantial stimulus or boost to policy flexibility.
By comparison, the petroleum deficit in the US is just -1.2%. Our growth outlook for emerging Asia is a real GDP gain of +6.1%, even amid China’s growth moderation, and is by far the strongest region in emerging markets (EM).
With high-quality bond yields falling in 2014, reflecting an outlook of greater monetary easing globally in 2015, it will be very hard to repeat 2014’s solid returns.
We would hedge most currency risks in global bond markets, and with that assumption, look for a 1.5% return in a globally diversified fixed-income portfolio.
Despite yields far below long-term averages, we hold a neutral weighting on long-term US Treasury debt. Monetary policy divergence has already been well reflected in the premium yields on long-term US treasuries compared to most other key sovereigns.
We expect 'convergence pressure' despite solid US growth. We are also neutral US dollar investment-grade corporates, which reflect low yields and some yield spread. High yield offers an interesting opportunity. We overweight it as the energy market collapse has created selective opportunities in a diversified portfolio.
For 2015, we continue to expect equities to outperform, reflecting an ongoing economic expansion, growing corporate profits amid low yields and central bank support. This is, of course, a consensus call. Where we may differ is that we believe we are in the second half of the global economic expansion with the multi-year rally in risk assets in its later stages.
The macro backdrop of the coming two years leaves us comfortably overweight risk assets for 12 to 18 months, but taking a three-to-five year view, we would be careful not to extrapolate the great recovery in risk. The industries and securities that have gone from bust to boom during the credit collapse and recovery over the past six years can’t repeat that performance.
Therefore, we would rotate from pure beta exposure to specific alpha-seeking equity opportunities. These include secular growth themes like EM staples and healthcare providers.
The oil price collapse of 2014 is likely to generate acute negative effects for a small part of the world, and mild positive benefits for a large part of the world. As always, there may be unintended and unforeseeable spillovers from financial distress among a small number of debt issuers.
The oil price collapse will boost profits of many consumers, but it is unlikely to stave off a wave of bankruptcies among oil consumers that were going to occur in any event. By comparison, the near halving in crude oil can generate bankruptcies and sovereign defaults among marginal producers.
As always, one can worry about how well markets can rationally dissect distress from the broader backdrop. High levels of central bank liquidity, even if the Fed begins a mild tightening cycle, argue that contagion is modest risk, not a central case. At the same time, the oil price collapse may add to political instability around the world, which remains an ongoing concern.
