The year ahead promises only “limited upside potential for investment returns”, according to the Russell Investments ‘2016 Annual Global Outlook’. The multi-manager and consulting firm believes “the bar keeps rising” but Australia’s yield-bearing shares are “less compelling than they appear”.
In the report, published just before the China-inspired global equity market plunge that greeted January, Russell says the 2015 scenario of “stretched equity valuations, low bond yields and narrow credit spreads” would intensify this year.
“This reality hit home in 2015. Global equities and fixed income barely posted positive returns for the year and anything related to emerging markets (EM) fared worse,” the Russell report says. “Looking ahead to 2016, the bar keeps rising.”
However, Russell notes that the tough investment markets would play out against broadly positive economic trends, at least in the developed world.
“The US, Europe and Japan should achieve trend-like growth in 2016. The economic cycle is most advanced in the US, and the US Federal Reserve (Fed) is likely to continue a gradual tightening process,” the report says. “But ‘gradual’ is the key word. Inflation is likely to remain low and the next recession is still not on the radar.”
While maintaining a neutral stance on fixed income and shares, Russell tips “mid-to-low single-digit returns for global equities” over 2016 with Europe and Japan the favoured destinations.
“US equities are expensive and profit margins are near record highs,” the report says. “Fixed income returns will be constrained by the upward pressure on yields from Fed rate hikes. Credit returns will be held in check by concerns over profitability and default rates.”
After a horror run in recent years, falling emerging market EM) equity valuations backed by currency adjustments could “prove tempting” to investors, Russell says, albeit urging a cautious approach.
“There may be an opportunity to take advantage of the value in EM assets during the year, and our team will be watching out closely for this,” the report says.
Japan remains the stand-out economy and equity market across the Asia-Pacific region, according to Russell, with the report also picking “soft landings in China and Australia; and steady growth in India—and, at lower levels, in New Zealand” over 2016.
Despite a “roller-coaster ride” last year, the report says China ‘A’ shares may have bottomed-out. “… We believe that the valuation excesses of mid-year have now been largely unwound,” Russell says. “… Only uncertainties regarding debt imbalances hold us back from a more overtly positive stance, for now.”
While the Australian stock market offered an “eye-catching” dividend yield of 5 per cent, the report says the value was “less compelling than it might at first appear”.
“The thin price-to-earnings discount [of Australian shares] to global valuations leaves us cautious about this materials- and financials-heavy market, however, as do the lack of earnings momentum and the stretched payout ratios,” Russell says. “Cyclical factors are acceptable, but no better than neutral. Sentiment is downbeat.”
– David Chaplin, Investment News NZ
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