OUTLOOK 2015: US bull run to continue in 2015

OUTLOOK 2015

US bull run to continue in 2015

Financial markets experienced a pick-up in volatility in the last quarter of 2014 and investors should expect further bouts in 2015 given the prospect of interest rate rises in the US. However, I believe the US stock market will deal with these rises quite comfortably. With subdued inflation and weak commodity prices, I think the speed and extent of rate rises is likely to be slower and more contained than many commentators are predicting.

While volatility is likely to have bottomed in this cycle, the direction of travel will remain the same and, in my view, the US bull market will continue right up to the presidential elections in 2016. Growth prospects for the US economy remain robust, allowing investors to continue to focus on positive corporate earnings and dividend growth.

I believe the US-led bull market is still intact and we will see new highs in 2015. It has ultimately been market confidence in the US recovery that has underpinned the bull market in equities and there is little reason to expect any change in that dynamic. Indeed, interest rates in the US will only move up because the recovery is felt to be strong and sustainable. The fact that inflation is low and likely to remain subdued due to weak commodity prices gives the Federal Reserve room for manoeuvre.

COMMODITY PRICES AND THE DOLLAR

I think the key relationship that will continue to shape what is happening in stock markets is the combined impact of weaker commodity prices and the strengthening dollar. The oil price has now fallen by around 25% since July 2014 and that weakness is likely to persist, given the structural shift in supply-side dynamics due to expanded US shale production.

The dollar has appreciated significantly against other major currencies in recent months. The issue is that when the world’s reserve currency appreciates, it deflates other assets, particularly commodities such as oil that are priced in dollar terms. This is the inverse of what happened over 2003-8 when a weaker dollar inflated commodities and supported emerging markets (see chart below).

The dollar’s appreciation is a result of ongoing structural improvements in the US. While these have been occurring for some time, what has changed is the monetary policy backdrop. Until recently, an environment of loose monetary policy was effectively keeping a lid on dollar appreciation. With the prospect of rate rises in 2015, coinciding with further quantitative easing in Europe and Japan, that lid has now been lifted. We could be in for a sustained and significant move higher in the US dollar combined with weaker commodity prices. Such a combination has traditionally been supportive for US equities.

US WILL CONTINUE TO LEAD GLOBAL MARKETS

The US economy continues to grow at a healthy pace; the structural improvements in the twin deficits are ongoing and will support further dollar appreciation. The collapse of hydrocarbon imports due to shale production has significantly improved the trade deficit, while the possibility of exports offers further scope for repair. More important has been the improvement in the fiscal deficit which has shrunk from around 10% at the start of the Obama presidency to around 3% now. The present administration has reduced the profligacy of the Bush era and federal outlays have actually declined as a result of the cessation of two costly wars in Iraq and Afghanistan. As a result, I believe Obama may end his presidency with a modest fiscal surplus – an impressive turnaround by any standards.

I think the outlook for US earnings also remains positive and it will be earnings and dividend growth that drive the market higher, more than compensating investors for the short-term headwinds provided by interest rate rises. Some sceptics have been anticipating a mean reversion in profits for some time now. I disagree with this – I think profits can stay high, supporting further valuation expansion. Over the last 12 years, we have seen a shift in the distribution of wealth in favour of companies and capital and away from labour. This relationship shows little signs of reversing.

The bull market of 2003-8 was about Chinese leadership and emerging markets outperforming developed markets with strong commodities thanks to a weak dollar. However, today’s continuing bull market is about US leadership and intellectual property sectors like pharmaceuticals, biotech and technology outperforming hard assets against the backdrop of a firmer dollar.

MIXED OUTLOOK FOR EMERGING MARKETS AND EUROPE… BUT A CONTINUING THIRST FOR YIELD

The case for the sustainability of the US economy, US earnings and US dividend growth remains robust then. However, what is good news for the US economy can present something of a hurdle for some other markets. In the last bull market of 2003-8, emerging markets had the benefit of two key tailwinds; the first was the rapid emergence of China and its double-digit economic growth; the second was the debasement of the US dollar and the concurrent rise in commodity prices. The export-led model that worked so successfully for many emerging markets in the last decade has now run aground. Individual emerging markets can succeed if they embrace structural reform and successfully adopt a more domestically orientated economic agenda.

Europe appears to be stuck in the middle; on the one hand, structural challenges remain, real growth is hard to come by and we are seeing a widening of credit spreads in the periphery. On the other hand, a weaker euro will be a significant support, particularly in combination with the falling oil price and weaker commodity prices generally, which act as a tax cut on economic activity generally. Together, these factors could give a modest boost to activity in 2015. Given the adjustment that has taken place in valuations, I am as positive on Europe as I have been for some time.

We presently have a glut of savings in the global financial system. With policy interest rates near zero and bond yields near record lows, this wall of money effectively has no ‘pricing power’, forcing investors to put their money to work to achieve a decent return. Within a broad global asset class context, dividend-paying equities still look attractive versus other assets such as bonds, and should continue to attract inflows from investors. Indeed, with the S&P yielding more than the 10-year treasuries and European markets yielding around 4%, I believe the equity income story will be one of the key catalysts that supports stock markets as the persistent thirst for yield continues in earnest.

SUMMARY

Investors should not be unnerved by the occasional bouts of volatility in 2015, as markets factor in interest rate rises. Fundamentally, I think the positive economic and earnings growth prospects for the US economy will ensure the five-year-long US equity bull market has further to run. While other markets can also continue to perform well, I do not see a fundamental change in leadership in this bull market, particularly given the prospect of a stronger dollar, which is traditionally a headwind for commodity-dependent emerging markets or those that still have significant dollar liabilities.

DOMINIC ROSSI is Global Chief Investment Officer, Equities at Fidelity Worldwide Investment.

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