Financial markets seem to have recovered from their sharp bout of volatility in the month of October. The question we now face is whether or not the drivers of volatility in the second part of 2014 will continue to affect markets in 2015.

“We expect financial markets to become more volatile, asset classes to become less correlated with one another and uneven economic growth to continue to dictate the direction of monetary policy,” said the report Outlook 2015: Sustaining returns in an uneven recovery published by Citi.

“With the end of a prolonged period of monetary easing in the US, the world’s main challenge remains that of sluggish economic growth. While we have seen the economy in the US consolidate its recovery, Europe and Japan still face significant challenges, with inflation well below their central banks’ targeted levels,” the report said.

“Emerging markets face equally challenging conditions, arising from a stronger US dollar and the prospect of rising US interest rates. We expect China to continue to try and strike a balance between growth and reform in its economy, while also taking important steps towards the liberalization of its financial markets.

“We approach 2015 with the world’s major central banks’ monetary policies diverging. On the one hand, the US Federal Reserve has ended its Quantitative Easing asset-purchase program, and both the Fed and the Bank of England are expected to raise interest rates. On the other hand, the European Central Bank and the Bank of Japan are expected to implement more aggressive expansionary monetary policies in an effort to counteract deflationary forces and stimulate economic growth.

“The impact of such divergent monetary policies and the consolidation of growth in the major global economies will drive the valuation of assets worldwide. We also expect to see the US dollar reverse its long-term weakness and appreciate against most currencies. The steps taken by China to open up its capital markets and the increasing weight of Chinese trade flows with the rest of the world should also bolster the role of the Chinese Yuan as a major international currency in the years to come.

“Geopolitical risks are another focus of ours for 2015. The dynamics in the production and in the price of oil, the ongoing conflicts in the Middle East, Russia, Ukraine, and social unrest in various regions of the world should also contribute to increased uncertainty and market volatility.

“In a world of divergent monetary policies, slow economic growth, and a return to more normal financial conditions, our 2015 Outlook examines the risks and opportunities ahead. We highlight the importance of alpha-generating strategies in investors’ portfolios, the opportunities that exist in an environment of rising volatility, the transformation of commerce and the increasingly important role of social investment in the construction of balanced portfolios,” the report added.

Global Equities

“Equities remain our favoured public-market asset class for 2015,” Citi said in the report.
“We are of the view that the global economic recovery is set to continue at least into 2016, while corporate profits and dividends are still rising solidly. Admittedly, equity valuations are not outright cheap. However, the current multiple of 16 times earnings for 2014 isn’t far above the long-term average, while bond valuations are.

“To avoid understating risk as the recovery ages, we often look at valuations based on real earnings over a trailing ten-year period to smooth out temporary peaks and troughs. On this basis, global equities currently trade on 21 times earnings. This is well above the historic average of around 17 times.

“However, the worst bear-market drops have generally begun when multiples have been higher than this and have been triggered by a shrinking economy, something which we don’t expect to see in the next two years.

“While some central banks are now looking to raise interest rates, monetary policy overall is likely still to support economic growth in 2015. We have only slightly lowered our tactical overweight allocation to equities from +6.8 per cent to +6.0 per cent and have only slightly decreased our tactical underweight allocation to fixed income from -6.8 per cent to -6.0 per cent for the start of 2015. But investors should not simply assume that the financial-market recovery that we have experienced since 2009 will continue indefinitely.

“For 2015, the returns we estimate for equities in each region are shown in figure 1. It is worth noting that there is a significant margin of error in these estimates given the volatility of equities as an asset class. It is also important to point out that exchange rates are likely to have a significant impact on equity returns in 2015.

“In many cases, cross-border investors should consider hedging currency exposure or taking into account the impact of foreign-exchange risks when allocating equities in their portfolios,” the report highlighted. – TradeArabia News Service