TORONTO and BOSTON, Jan. 22, 2015 /CNW/ -- In a new report available at ManulfeAM.com, "The Salient Seven: Seven Key Economic Themes for the Year Ahead and Beyond," Manulife Asset Management chief economist Megan Greene and Robert Boyda, co-head of the Portfolio Solutions Group, outline the major forces shaping the global economy in 2015 and beyond, and assess their implications for investors.
Amid plummeting oil prices, uncertainty over quantitative easing in Europe, and questions about the ability of Abenomics to return Japan to sustainable growth, among other issues, it can be difficult for investors to discern a coherent story line for detecting winners and losers in various asset classes, Ms. Greene and Mr. Boyda write.
While many investors may be focused on the likely trajectory of oil prices, the report's authors explain why they believe it is important not to be overly distracted by an economic dynamic that seems likely to be a relatively short-term phenomenon. Mr. Boyda explains: "In our view, falling oil prices are more a combination of financial liquidation, as traders close out their positions, and short-term supply issues than because of a global collapse in demand."
"As oil prices fall near to US$45 per barrel, there has already been a significant retrenchment in drilling and production plans across the oil industry. A number of producers, for example in fracking or oil sands, likely will rein in future production. We expect oil prices to remain low for around six months. Assuming that the current price collapse brings about greater market discipline and projects continue to be cancelled, we believe that, after mid-2015, oil prices will rise again and likely stabilise between US$60-80 per barrel."
The report goes on to identify seven global macroeconomic trends to which few nations are likely to be immune. Investors who understand the implications of these, the authors believe, may determine what will drive economies and markets going forward. They are:
- Over-indebtedness: Total indebtedness by governments and households continues to increase.
The upshot for investors is that while demand for fixed income remains robust in the United States, opportunities in fixed income are likely to be restrained by an overabundance of debt. In the midst of equity market volatility there may be a widespread desire to flee to fixed income, but this may not provide the growth opportunities that many investors are seeking.
- Ample Liquidity: The global economy is awash with liquidity and credit, thanks to successive rounds of easing measures by major central banks.
Investors should focus on the fact that, with so much liquidity being injected into the global monetary system, equity markets are unlikely to come under real pressure anytime soon. While many investors still typically maintain a home bias, monetary policy dynamics offer a strong case for casting a wider investment net and in particular, examining opportunities in international equity markets in 2015 and beyond.
- Beggar-thy-neighbor currency actions: Countries are hoping to boost demand and growth by increasing their competitiveness via a weaker currency.
A weakening euro, yen and renminbi will likely boost corporate profitability and competitiveness in the Eurozone, Japan and China. Investors should consider that this may help to support growth in these economies, and with it, equity markets.
- Low government bond yields: Secular stagnation and easy monetary policy is likely to mean the continued compression of government bond yields.
The report's authors write that their expectation is for long-term yields to remain low over the next five years. While some analysts believe current low yields are simply a result of normal business cycle fluctuations, their view is that the current era of oversupply represents a structural break with the past. In the absence of an increase of global demand, U.S. long-term yields should remain below the historical "normal" of four percent over the five year forecast period. This should be factored into investors' asset allocation strategies.
- A new swathe of regulation: As capital requirements for other assets rise, investing in sovereign bonds has become more attractive from a capital cost perspective.
Increased regulation is expected to persist for a number of years, as regulators and policymakers continue to grapple with how to avoid a repeat of the global financial crisis. One potential result of increased regulation is lower profitability for financial services firms and an underpinning of sovereign bond markets as sovereign bonds become relatively more attractive to investors.
- Demographics and the drive toward debt: An aging population encourages many investors to shift into fixed income from equities.
As the global population ages, investors are adopting more risk-averse strategies. Aging demographics have already impacted policy decisions and macro-economic trends in developed markets such as Japan, North America and Europe, but the global economy and its bond markets are bracing for the emergence of the new geriatrics on the block -- from aging Asia. The demographic shift will only accelerate in most major economies, supporting shifts from equities to bonds in 2015 and beyond.
- Lowflation: Lack of global demand is expected to translate into little upward pressure on inflation, with many central banks missing their inflation targets.
As a result of lowflation, both short and long-term interest rates are expected to rise very slowly over the next five years. Short-term rates should increase slightly faster than long-term rates as central banks begin tightening monetary policy. Rising policy rates will push down prices for bonds with short maturities, increasing their yields relative to long-term securities. This could make fixed income opportunities for bonds with longer maturities less attractive. Subdued inflation will also make it more difficult for some countries to stabilize their debt burdens.
Ms. Greene and Mr. Boyda conclude that the Salient Seven generally provide structural support for equity prices, with global stock markets benefiting from ample liquidity and low inflation. Some equity markets also may receive a boost thanks to currency depreciations. The Salient Seven as well point to further pressure on fixed income, given significant debt overhang and lowflation. A continued compression of government bond yields is likely to remain the case for quite some time.
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