Investors need to widen their investment horizons this year.
The US economy is expected to accelerate this year, as the weakness in the first quarter of last year is unlikely to be repeated.
Europe and Japan are also likely to post slightly stronger growth next year.
The main fly in the ointment is China, which is likely to decelerate somewhat as the authorities remain focused on reforms that naturally represent a trade-off between short-term and long-term growth.
Meanwhile, inflation is expected to remain relatively benign, with the global output gap remaining wide and lower oil prices reducing inflationary pressures. This should allow the majority of central banks to loosen monetary policy, supporting risk appetite.
However, this year traditional asset classes are likely to generate lower, but still positive, investment returns. Global equity valuations have generally increased over the past two to three years. This is not something to be too concerned about, but it does mean that forward-looking returns are unlikely to be as strong as they have been (they have risen almost 50 per cent since the end of 2011 on a total-return basis).
Meanwhile, bond yields have discounted a lot of disinflationary pressures already, which means any upside surprise on the growth and inflation front could undermine returns here as well.
Volatility is also likely to increase this year.
The first Fed rate hike of the cycle is normally a period associated with increased market volatility.
The good news is the Fed looks keen to err on the side of caution. Therefore, any rise in interest rates is likely to be gradual and well-signalled.
The bad news is the market is pricing in a slower pace of rate hikes than the Fed’s committee members are forecasting. The gap will have to narrow this year, either with Fed members reducing the pace of forecast rate rises or the market adjusting their expectations up somewhat. Expect a combination of the two, but this still implies a market adjustment that could increase short-term volatility.
We at Standard Chartered do not believe that the end of the developed market equity bull run is near. History teaches us that equity markets usually rise well into the rate hiking cycle – usually until the Fed’s focus shifts to combating inflation rather than supporting growth.
However, lower returns and higher volatility will make gains feel much harder to achieve than they have been since 2012.
It is against this backdrop that investors need to widen their investment horizons to areas less travelled. This includes taking advantage of higher volatility by selling options as volatility spikes – a more conventional approach would be to buy Developed Market equities on dips, a strategy we expect to remain profitablethis year. It also includes selective investments in some Asian local currency bond markets such as China and India, an area that clearly fits into the theme of adopting a diversified approach to income investing.
Finally, there are many alternative strategies that are likely to generate a good risk-return profile in 2015, relative to the more traditional asset classes.
Overall, we remain constructive on risk assets, despite the likelihood of the Fed hiking interest rates for the first time since 2006.
However, we would recommend investors consider complementing global equity investments with less traditional sources of returns.
Steve Brice is the chief investment strategist of the wealth management group at Standard Chartered Bank
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