Global monetary policy differences in 2015 will give different paths to return generation as well as periods with a higher degree of nervousness and uncertainty, which we saw later in October 2014. As a stock investor, one must, therefore, get used to a lower equity return, but with a continued positive contribution from the US dollar.
For a number of years, the economic development has been dominated by massive monetary policy stimuli through the central bank’s liquidity pumping out. In 2014, wealth management argued that the US companies were in a transitional period when the need for monetary-policy stimuli became ever smaller. The period ended in 2014 by the fact that the US Federal Reserve completely stopped buying US government and mortgage bonds. This means that the US economy is now on its own and must be drawn from fundamental economic improvements more than monetary policy measures. The end of the transition period means a regime change in relation to the return generation on the US stock market, while the US monetary policy is expected to be contractual.
Previously, the return on US equities was primarily offset by two factors. First, US companies have to a large extent adapted costs and streamlined operations in the wake of the financial crisis. The positive development in earnings has thus taken place without the same improvement in demand components and revenue, which is why this development with the current record high-profit margins must be said to be complete.
Secondly, monetary policy measures – primarily through quantitative easing – have increased investors ‘expectations that these would at some point have a positive effect on the US economy and thereby also on the companies’ earnings generated through demand and revenue.
Expectation building has meant that global investors have been willing to price US stocks more expensive on the expectation of its accelerating earnings. Precisely this so-called multiple expansion (shares traded at higher prices measured in relation to earnings) has drawn equity returns since 2012 and has meant that US shares can no longer be characterized as being cheap.
In 2015, therefore, the equity return must be driven by fundamental improvements in demand, which propagate to the companies through an improvement in revenue. With a record high-profit margin, a very large part of this revenue is converted into earnings. Thus, earnings will be the primary driving force for the US equity return. As Formuepleje does not expect the same positive effect from cost adjustments, efficiency improvements and monetary policy measures in the US market in 2015, as an investor everything else must expect a lower return on equities compared with earlier. So, as a Danish investor, one can expect a positive currency effect from the US dollar, I come back to later.
Strong divergence in global monetary policy
Where the US is “back to basics” in terms of return on the US stock market, the situation is different in Europe and Japan. In parallel with the United States, Japan has introduced quantitative easing in the Japanese economy in an attempt to lift the economy out of decades of low growth. The easing has so far had a limited effect on the economy, but also on both equity returns and valuation.
In Europe, the head of the European Central Bank (ECB), Mario Draghi, has in the autumn of 2014 strongly indicated that it will do what is necessary to correct the declining inflation and, in particular, falling inflation expectations. Property management, like the rest of the market, expects this to be interpreted in the direction of the acquisition of European government bonds in early 2015.
Japan and expected Europe have thus moved into the path that the United States left for years to kick-start growth and inflation. The challenge is that where the US is without monetary-policy stimuli, but with a significantly better fundamental health status at both macro and micro levels, Japan and Europe stand with zero growth, pressure on inflation and companies that continue to improve efficiency in trying to find earnings growth. In 2015, the marked difference in global monetary policy will be a central theme where investors must place their money. Are the US companies able to profit from the operational positive developments we see in the US economy? And/or do central banks in Japan and especially Europe manage to surprise those already high expectations in the market of the magnitude of monetary policy stimuli?
Oil price drops and the consequences of different monetary policy
A natural result of the pronounced divergence in global monetary policy has been a sharp increase in the value of the dollar against both the yen and the euro. In 2014, the dollar rose by 13 percent against the yen and 12 percent against the euro. In other words, this means that where Japanese and European companies with US export focus are favored by a weaker currency, it also means that US exporting companies are largely paying for the lack of convergence of global monetary policy through a stronger dollar. Overall, the US is a domestic-oriented economy, but the US export wind will have an impact in 2015.
With a US central bank expected to raise interest rates in 2015 as a result of the continued economic improvement, it should also be able to expect further strengthening of the dollar against the yen and the euro, although this position is one of the most widespread in the financial markets.
On the other hand, pressure on both European and American oil since the summer of 2014 is estimated to have the greatest effect in the US. This is because the dollar strength relatively speaking makes oil more expensive in Europe compared to the US.
Overall, the oil has fallen by 48 percent and 42 percent, respectively, in 2014, and in reality acts as a fiscal easing. The ordinary consumer of energy – either through house, heating/cooling, gasoline, diesel or anything else – will experience a greater availability as a result of the fall in oil prices, while energy-intensive companies, including the manufacturing and aviation industries, will experience a cost-saving, like everything. Other things to be expected to propagate to earnings growth. Conditions that will support growth on a global scale and to varying degrees.
The global equity investor has put himself on the chair edge
An American stock market, which to a greater extent than previously, is drawn by the companies’ operations and earnings growth, makes quite natural – unlike earlier – that investors in the US stock market will experience larger price fluctuations at times. In recent years, the US central bank has been a natural part of the direct and indirect return generation on the stock market. With the removal of this factor, US companies are back on their own feet dependent on US and global consumers.
This, as was the case in mid-October 2014, will, of course, lead to situations where fear and speculation dominate compared to developments in fundamental conditions. And with a central bank that is no longer a permanent component of the US bond market, one should, therefore, expect a number of situations where the stock market will be challenged as a stock investor. However, wealth management still believes that equities as an asset class are attractive both given the fundamental conditions and in the relative perspective so that the equity portion of the wealth management associations’ equity portfolio remains maximally utilized within the given investment limits.
The ultimate proof of the global monetary divergence will be when the US central bank is expected to raise its key interest rate during 2015. The central bank raises interest rates because the economic development is positive and that, as a result, inflation pressure can be recorded or expected. Notwithstanding the fact that interest rate rises in the wake of high economic activity, these have historically tended to increase volatility in the stock market, which will of course also be the case in 2015. Over a longer horizon and with limited structural changes in interest rates, it seems that however, it is still possible to generate a reasonable equity return.
Continued positive on equities, but expect lower returns compared to earlier
2015 will be a stock year, where large monetary policy differences will dominate the agenda. Differences that have arisen in the way one as a country or region has chosen to attack the local challenges that arose in the wake of the financial crisis. The result will be, among other things, a continued strengthening of the US dollar against the yen and the euro for the benefit of Japanese and European exporters.
Larger US dependence on each company combined with a contravening US monetary policy will change the risk profile of what we have been used to and increase the likelihood of nervousness, fear, and corrections as was the case in October 2014.
The expectation of a positive global growth trend led by the US and China, fundamentally strong companies, a global consumer in recovery and tailwind from a declining oil price and currency conditions, means that at the start of 2015, the wealth management associations will continue to be exposed to maximum shares within the current investment framework. However, return on investment must, as an investor in 2015, expect a lower equity return than in previous years. Basically, 5-10 percent measured on the global index, but with a positive dollar effect on the top as a Danish investor.