2015 investment year in review
By Russell Investments, UniSaver's investment manager and consultant
While the ride through 2015 contained many ups and downs, the UniSaver scheme ended the year in December with strong returns across the board. While returns were not as outstanding as in recent years, each of the options outperformed its benchmark and was well above the median KiwiSaver fund of similar risk. Looking forward we expect another year with the potential for volatility and limited upside for investment returns, despite our forecast of trend growth in the major developed global economies.
A strong start in markets
Global financial markets began the year well, driven in large part by the European Central Bank (ECB)’s decision to follow the lead of the United States with its own quantitative easing program. Under pressure to combat the threat of deflation and revive the region’s ailing economy, the ECB said it would purchase EUR60b of euro-zone government bonds each month from March 2015 to September 2016 – with scope for increases if needed. Markets were also supported by Greece’s agreement with the EU to keep its government solvent and expectations that the US Federal Reserve (Fed) would raise interest rates only gradually. Stocks in the US, Europe and Japan all hit record highs in early 2015.
Mid-year worries driven by Greece and China
This initial momentum dissipated as escalation in Greece’s debt crisis overshadowed some encouraging earnings results of American companies and stronger Japanese and euro-zone growth data. Investors’ hopes that an agreement between Greece and its creditors could be reached proved false, after Greek Prime Minister Alexis Tsipras’s surprise decision to call a referendum on proposed budget reforms. The market’s reaction to this decision was swift, with stocks plummeting as investors quickly cut their exposure to risky investments. To make matters worse, Greece subsequently failed to repay EUR1.6b due to the International Monetary Fund. This was the first time a notionally ‘developed’ country had ever defaulted on IMF debt.
Locally, the RBNZ changed tack over the first half of the year as expectations shifted from interest rate hikes to expectations of cuts. These materialised in June with the first of four cuts of 0.25%, fully reversing the hikes conducted in 2014. After a short lived recovery, dairy commodity prices resumed their declines, contributing to significant falls in the New Zealand dollar. This pattern was also reflected in other commodities. Oil recovered to US$60 a barrel but then gave way through mid-year to further significant declines.
Meanwhile, fears that slower growth in the China would derail the global recovery brought a boom in its equity market to a swift conclusion. The selloff in China would ultimately continue through July and August, putting significant downward pressure on both developed and emerging markets, and causing commodity prices to plummet to multi-year lows. The S&P 500 Index hit its low for the year in late August, at around 1867, 12% off its peak.
Central banks stay centre stage towards the end of the year
Sharemarkets were further pressured by the Fed’s decision to leave interest rates on hold in September. Investors worried that the bank’s decision to wait signalled a lack of confidence in the economic recovery. On the plus side, sentiment was helped by news that Greece had finally reached an agreement with its creditors. Whether this represents a long term, sustainable solution for Greece remains to be seen.
As we approached the end of the year, central bank policy remained a key driver of markets. When the Fed finally lifted interest rates in December investors chose to interpret the bank’s decision as a sign that the US economy is strong enough to withstand higher borrowing costs. Investors were also comforted by the Fed’s promise that any subsequent rate hikes will be gradual.
Another round of encouraging US and European earnings results and additional Chinese stimulus boosted sentiment further. Limiting these later gains were sharp declines in commodity prices and fresh geopolitical concerns; the latter including terrorist attacks in Paris, Turkey’s downing of a Russian fighter jet and Saudi Arabia’s latest standoff with Iran.
We believe 2016 will likely be another year of limited upside potential for investment returns. The good news, however, is that the outlook for major developed economies is still reasonably robust. The United States, Europe and Japan are expected to achieve trend-like growth over the next 12 months.
However, stocks are considered to be relatively expensive, especially in the United States. Profit margins will continue to be pressured by a rising US dollar and a gradual lift in labour costs. We remain more positive on Europe and Japan. We rank both of these markets ahead of the US due to more attractive valuations and greater potential for profit growth. We are a bit less optimistic about the Asia Pacific region where we see economic and market conditions as less dynamic. While sharemarket valuations in emerging markets continue to look attractive, many emerging economies faces significant headwinds in the form of falling commodity prices and higher interest rates in the United States.
Locally, our strategists see an increasing possibility of the Reserve Bank of New Zealand cutting rates further. Inflation expectations appear to be falling, with 2 year ahead expectations falling to 1.6% in the latest Reserve Bank survey, well below its target of 2%. Cuts are far from certain however, as lower dairy prices are mitigated by strong domestic credit growth, immigration and tourism.
Ongoing ups and downs in markets in 2016 seem a given, however for individuals in UniSaver, long term outcomes will be primarily driven by Option choice. This choice should be considered in light of your own time horizon and risk tolerance, rather than attempting to time market movements which, as 2015 once again confirmed, are difficult to predict in the short term.