|All the CIO interviews|
There were many:
- While we thought oil prices would struggle and remain around $90/barrel, falling below $65 was a surprise;
- The Treasury rally given accelerating US growth;
- Continued fixed-income fund inflows, as we expected more flows into the equity space;
- Poor hedge fund performance, given the uptick in volatility;
- Defensive sector resiliency – average outperformance of defensive sectors versus cyclicals year to date is around 600 basis points;
- The Republican sweep across congressional and gubernatorial races – while we expected them to win, not necessarily by as large of a margin... now 54-46 advantage in the Senate;
- And while we expected large cap to outperform small cap in 2014, the magnitude of the underperformance of small cap stocks was larger than expected.
We are anticipating 3.2% in the US, and Asia should once again be led by China growing 6.8%.
Despite our expectation for a gradual recovery in global GDP, muted inflation, the potential for policy error, and investors sceptical of growth prospects will likely limit the rise in long-term US Treasury (12-month forecasts of 10-year 2.6%) and German Bund (10-year 0.95%) yields in 2015. This modest rise should result in little to no return potential for sovereign investors. We recommend an overweight to higher yielding fixed-income sectors. Credit and emerging-market hard currency bonds should be supported by low default rates, improving corporate and government balance sheets and stable sovereign rates.
Equities. With bond yields at or near record lows and spreads historically low, returns for fixed-income investors will be muted (less than 5%). However, the modest acceleration of growth in 2015, robust earnings growth (8% to 10%), shareholder friendly activities (eg buybacks, dividend increases, M&A, etc), accommodative monetary policy and low interest-rate environment should support equity returns between 5% to 10% next year.
Biggest unknowns/risks for 2015?
- Geopolitical as the decline in oil prices creates the potential for civil unrest.
- Political with key elections in Spain and the UK.
- Policy error if ECB fails to deliver or stimulate growth and/or the Fed raises rates too early.
- The negative effects of oil's decline are more substantial than forecast (e.g. earnings, credit stress with high yield defaults, steep drop off in capex spending).
- Another winter similar to last year that threatens heightened expectations for growth.
- Treasury yields sharply accelerate as Fed pulls away from Treasury market. Municipal defaults as midwestern states suffer from production shut downs and heightened unemployment.
- Cyber attacks in current global technology world.
- Banks earnings get squeezed from tight trading environment (low spreads), flatter yield curve and lack of loan demand.
- Dollar rally accelerates well beyond our targets and hampers earnings environment for multinationals.
- Consumer and business confidence deteriorate