While global markets have largely traded sideways over the past couple of years, that hides wildly divergent trends for defensive, income-producing assets and growth stocks, which have become ever-more expensive, and anything to do with commodities, which has been hammered.
For all the uncertainties that lie ahead in 2016, many investors’ outlook for the New Year will depend on the answer to one question: can we expect more of the same?
The ‘buy low, sell high’ mantra would dictate that 2016 would be the year to scoop up bargain-basement miners and oil stocks. But then you could have said the same thing at the beginning of 2015.
Over the last couple of years, it hasn’t paid to take a contrarian approach to investing. To beat the index, it’s only really been necessary to not own oil stocks or miners, or at least own them in minimal amounts. That’s one of the main reasons why it’s been possible for fund managers to be sitting towards the bottom of the performance league tables and yet still beat the market in recent years.
But Alex Wright, manager of the Fidelity Special Situations fund and Fidelity Special Values investment trust, warns against complacency.
‘The market trades on a valuation more or less in line with historical averages, so neither looks dangerously expensive nor attractively cheap. However, digging a little deeper reveals significant differences in valuations between companies and categories,’ he said.
‘As we enter 2016, I think investors would do well to ensure that their portfolios do not rely on recent trends continuing indefinitely. If there is one lesson the stock market teaches us over and again, it is we must be prepared for change.’
Leading fund managers give their view on how they see the major global stock markets performing in 2016.
Dividend danger in the UK
UK dividends look set to come under intense pressure in 2016, after a sustained growth in payouts, unmatched by earnings, has led a number of stocks to look dangerous exposed.
The pay-out ratio – the proportion of company earnings paid out in dividends – has hit a 20-year high, leading to dividend cover, a measure of the sustainability of payouts, falling to its lowest level since the financial crisis.
Only one of the FTSE 100’s top 10 yielders – cruise ship operator Carnival – has dividend cover of more than two times with five only offering cover of one times or less. Embattled miner BHP Billiton, on a yield of 10.9%, is covered only 0.4 times.
Last year saw a number of high profile dividend cuts, from Centrica, Glencore, Sainsbury’s and Tesco, and experts expect similar this year.
‘The sustainability of UK dividends will remain a hot topic in 2016, especially in the context of the path of commodity prices in the next 12 to 18 months, said Richard Marwood, manager of the AXA Distribution fund.
‘If we stay at such low price levels, commodity-related companies will continue to face very tough decisions on costs and dividend payouts.’
Reassuringly expensive US?
Barring the rollercoaster ride for investors in China’s Shanghai Composite index, the US’s S&P 500 index has been the best place to be over the last three years.
The 66% returned enjoyed by investors in pound terms over the last three years has left the US market trading at expensive levels relative to other major global markets. A price-earnings ratio, using forecasts of 2016 earnings, of more than 16 times beats the 14.5 times on the FTSE 100, and is well ahead of the 10.9 times level at which emerging markets stocks are trading.
Is this too expensive? Russ Koesterich, global chief investment strategist at fund group BlackRock, thinks so. ‘Valuations on US equities remain elevated by most measures, particularly based on long-term cyclical earnings,’ he said.
‘Profit margins are likely to remain under pressure as wages firm. In addition, should the dollar appreciate further, this will negatively affect companies dependent on exports. As such, we only have modest expectations for US equities in 2016, and would not expect a revisit of double-digit returns.’
Not so for Tom Stevenson, investment director for personal investing at Fidelity, who argues US stocks are expensive for a reason.
‘Although Wall Street looks increasingly fully valued, I continue to think this is justified by America’s better prospects, exposure to the market’s most interesting ideas (in particular in technology and other innovation-driven sectors) and the probability that US consumers will finally start to spend the ongoing benefits of a very weak oil price,’ he said.
It is those innovation-driven areas that also account for Neptune US Opportunities manager Felix Wintle’s enthusiasm. Low cost inflation would continue, he argued, while wage growth would boost consumption.
‘We expect the US consumer to benefit and technological innovation in the technology and healthcare sectors to continue,’ he said. ‘We therefore remain bullish on the US and the US stock market.’
Turnaround for emerging markets?
Will 2016 prove the year emerging markets finally recover? Stock markets in the developing world have been in the doldrums for three years now, and they have been the worst major market in which to hold your money over the last five.
On the face of it, it’s difficult to see the signs of a recovery: the US has just begun raising interest rates, hiking the price of developing economies’ dollar debt and spurring investors to seek more secure returns in the world’s largest economy.
But then, they are very cheap. Emerging markets trade on a price-earnings ratio, using projected 2016 earnings, barely in double figures, well below other global markets.
‘Emerging market valuations – in terms of price-to-book ratios – are relatively depressed versus history,’ said Ross Teverson, manager of the Jupiter Global Emerging Markets fund.
‘At a time when valuations have been at or around these levels, strong long-term returns have often been available to investors willing to look beyond short-term headwinds.’
Nick Price, manager of the Fidelity Emerging Markets fund, pointed to depressed currencies and the subdued oil price as crucial to the plight of the sector.
‘2015 has already exhibited a high degree of currency depreciation of most emerging market currencies versus the US dollar,’ he said.
‘To this end, weaker emerging market currencies actually provide a tailwind for emerging market exporters. They make products and services derived from emerging economies more cost competitive, making them attractive in the face of hopefully improving demand as the global economy continues to recover.’
Exporters could also continue to benefit from the boost to global growth from a continuing low oil price, even though some oil-producing developing economies will continue to suffer.
‘Falls in commodity prices have not been bad for everyone,’ he said. ‘Take India, for example. As a net commodity importer, both the economy and the household have benefited from the impact of lower price inflation as the prices of fuel and food have fallen.’