The spectre of the recent fall in oil prices has cast a pall over virtually every global market, stoking deflationary concerns, unleashing a new wave of monetary stimulus across the globe, and giving investors reason to pause. Much like an unwelcome party guest, the sharp drop in crude put an end to nearly five years of seemingly unstoppable momentum. 2014 saw a lot of reasons for investors to be concerned; a potential Ebola outbreak, escalating tensions in Russia, and a potential triple-dip recession in the Eurozone. None of this rattled markets; it seemed as though we were destined to ring in the New Year comfortably locking in another year of 10+% gains. As we know, the sharp decline in oil crushed markets around the world, but the impact was magnified here at home, as evidenced by the TSX backtracking roughly 13% in a little under 6 weeks. However, as the price of oil stabilized, markets resumed their upward trajectory and ended the year on a positive note. The recent gut check the markets have experienced reinforces the need for continued vigilance of macroeconomic trends, and careful balancing of risk and reward as we move ahead into the uncharted waters of 2015.
The United States: A Battle of the Birds: In late 2014 and early 2015, the question has shifted from not “if” but “when” the Federal Reserve should raise their benchmark interest rates. This, coupled with the recent end of QE3 in October, marks the end of the “easy money” policy practiced post-financial crisis. In anticipation of future rate hikes, markets have sent the U.S. Dollar roughly 20% higher since October. The strength of the Dollar puts the Fed in somewhat of a pickle; consumers have more discretionary income, as imports have become relatively cheaper and oil prices have fallen, but raising rates too quickly risks clipping the wings of an economy that, after five-plus years of support, is just now taking flight. I anticipate the Fed to raise rates in September of 2015, although given recent history, a postponement of the hike would not surprise us.
Canada: It’s a Crude World: Canadian markets remain fairly tied to the price of crude oil, a view reinforced by the recent slide in the TSX mirroring the drop in oil prices. However, the TSX has recovered much more sharply than Crude itself. This could be attributed to the positive effect of low oil prices on consumers, as well as the benefit of a weaker Canadian Dollar for exporters. Unfortunately, if the price of oil continues to languish, these effects will be at best muted by the decrease in job growth in provinces like Alberta that previously led the charge. The addition of deflationary concerns due to the sharp drop in oil led the Central Bank to cut rates by a quarter-percent in January, in an effort to stoke exports and curb contraction. Despite these concerns, we believe that there will be stabilization in oil prices, and see Canada as a stock-picker’s market. Accordingly, we plan to focus on export-driven companies, while being cognizant of their relationship with crude oil prices in an effort to minimize risk.
European Markets: Eroding Euro: European markets have seen their uniting currency, the Euro, slide back to near-parity with the U.S. Dollar, after fetching nearly $1.40 USD as recently as May of 2014. This could be attributed to the divergence in monetary policy between the two countries, as the U.S. ended stimulus, while the ECB was forced to continue due to ongoing concerns about growth, or lack thereof. The continued Greek Drama over austerity packages, tensions over Ukraine, and erosion of support for the European Union as a whole have weighed heavily on the region. These concerns, coupled with the structural decline in demographics, highlighted by an aging population (the IMF sees the ratio of retirees to workers doubling to 0.54 by 2050), will increase the pressure on already strained social systems, and the governments that provide them. In light of these headwinds, we expect to be underweight on Europe-focused companies, but see select opportunities in companies strategically positioned to capitalize on these trends.
Japan: The Song Remains the Same? Japan has also felt the weight of demographic decline over the last decade, and, if Abenomics works, could provide a blueprint of sorts for Europe to overcome its’ similar decline. Whether Abenomics proves successful remains to be seen; GDP growth is still expected to languish at sub 1% levels, while inflation has not fared much better, despite its near zero interest rate policy for the last 20 years. One thing that has been proven regarding Abenomics is the market’s fondness of the policies: The Nikkei has nearly doubled since the beginning of 2013, when Abe was elected to his second term. However, due to the economic and demographic headwinds facing the country, we will likely be underweight Japanese companies for the near-term.
BRICs: Diverging Paths: The leaders of the developing markets find themselves headed in opposite directions. On one hand, Brazil has seen economic growth turn to contraction as the government has decreased spending in an effort to avoid potential credit downgrades. Concerns about inflation, projected to come in around 8%, as well as ongoing political instability tied to corruption surrounding Petroleo Brasileiro paint a dark picture for Brazil. Russia has fared even worse, with the IMF projecting growth to come in at -3% for 2015 amid increased sanctions over the Ukrainian conflict and continued weakness in crude oil. On the flip side of the coin, India and China continue to drive global economic growth, a trend we see continuing over the long run despite some short to medium-term concerns. China’s GDP growth is moderating as the country makes the transition from its prolonged period of intense, FDI-driven growth, to a more mature, consumer-driven economy. How the transition handled is crucial to the well-being of the global economy moving forward. A strong and growing Chinese middle class will drive global growth for years to come, so long as they can sidestep a potential real estate bubble, concerns over the banking sector, and encourage a “soft landing”. India continues to showcase its strength, with GDP expected to grow at a rate of 6.3% in 2015 after successful policy reforms lead to an increase in investment activity. Similar to China, India is also experiencing large growth in its middle class, which is expected to drive growth moving forward. Both countries would be well served to continue focusing on increasing their citizens’ human capital via increased access to education, as well as continuing to build out infrastructure to provide a conduit between their urban and rural areas. These two countries will be looked upon to drive global economic growth in the coming years, a trend we plan on capitalizing on.
Despite some of the concerns nagging investors, we expect markets to continue their climb, although perhaps a bit more cautiously than we’ve seen over the last five years. With the impending rate hikes in the U.S., the slowing growth outlook in China, and continued weakness in Europe, there could very well be some turbulence ahead for global markets. However, this only serves to emphasize the need for deliberate, thoughtful analysis and adherence to our long-term investment horizon. Now, more than ever, effective coordination of fiscal and monetary policy is crucial to the perpetuation of global economic growth.
YUSIF Portfolio Manager