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Buckle up for a rocky ride

Diversification is a cornerstone of any disciplined investment strategy, especially given the heightened volatility in the markets.

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One would be well served by a diversified basket of equities, income-generating assets and alternative strategies, according to Mr Brice.

FOR investors wondering what 2016 would be like, the first month of the year should have left no doubt that the environment is not going to get easier for generating returns. A global benchmark stock index was down in mid-January by as much as 19 per cent since hitting a record high in May 2015, before recouping some of the losses. Several emerging market equity indices are firmly in bear-market territory, having dropped more than 20 per cent since last year's peaks.

How should we position ourselves for what could be an unusually rocky year? For answers to this $64 million question, one must turn to a few time-tested principles of investing - diversify across asset classes, rebalance assets at regular intervals in order to lock-in gains from better-performing assets and buy inexpensive ones, and, most importantly, stay invested - because cash continues to pay meagre returns in a world of extremely low interest rates.

While we remain invested, there are three factors that, we believe, could guide the outlook for risk assets this year:

  • China's currency policy in the context of its slowing economy;
  • the longevity of the US business cycle; and
  • the net impact of low energy and commodity prices on global growth.

The Chinese yuan has weakened almost 6 per cent over the past six months, leading to speculation that the central bank could allow further depreciation to counter slowing growth. This, in turn, has led to large-scale capital outflows from China.

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China's currency policy is critical for Asia and other emerging markets because, for years, the yuan's stability has provided an anchor for the developing world. Based on the trading pattern so far, we do not see this anchor-role changing significantly. The latest regime shift in China's policy which ended the yuan's long-standing peg to the US dollar means that the currency will be increasingly aligned with those of China's biggest trading partners.

In other words, the yuan is likely to be broadly stable against major non-US dollar currencies even if it depreciates against the US dollar. This should reassure investors over time, although the pace of capital outflows is something to watch in the short term.

THE US BUSINESS CYCLE

Another factor that is likely to dominate this year is the longevity of the US business cycle.

If you believe we are close to the end of the cycle, ie, closer to a recession, then a defensive investment stance would be warranted.

We take a more constructive view. While this cycle, now in its seventh year since the 2007 to 2009 Great Recession, is already one of the longest on record, the US Federal Reserve is still focused on supporting growth rather than fighting inflation. This message came out loud and clear at the Fed's recent meeting in January where policymakers issued a dovish statement.

As such, we see increased chances of the Fed slowing the pace of rate hikes to around two 25 basis point increases this year, compared with the Fed's projections of four hikes.

Low borrowing costs, combined with a still-robust labour market (despite rising job losses in the energy and materials sectors), are likely to sustain the "Goldilocks" environment for US consumers. We believe this should sustain the US economic expansion for another 18 to 24 months.

Finally, we see low oil prices providing a net benefit for the global economy. The fall in energy prices, if sustained, could amount to a net transfer of trillions of US dollars of global wealth from energy producers to consumers. Since consumers are the biggest drivers of growth in the world's largest economies, the net gains from lower oil prices are likely to offset the losses suffered from cuts in commodity sector investments and employment, at least over the medium term.

The alarm caused by the persistent decline in oil prices is understandable, given that a sharp decline in oil prices have presaged recessions in past decades. However, in this cycle, oil's decline to a 12-year low has been driven by soaring global production (primarily from US shale deposits in recent years and Iraq) rather than falling demand. In fact, demand continues to rise worldwide, notably in Asia.

We expect demand to catch up with supplies at some stage later this year which should lead to oil prices settling between US$40 to US$60 per barrel.

Even at these prices, oil is likely to put a cap on inflation expectations, keeping monetary policies worldwide supportive of growth. This view was driven home recently by both the European Central Bank, which cited low inflation as a reason to consider further monetary easing in March, and the Bank of Japan, which surprised markets in January by cutting a key interest rate to negative for the first time.

INVESTING IN RISK ASSETS

With central banks staying accommodative longer, we believe this can still be a good point of the cycle to be invested in risk assets such as global equities - which are likely to continue to outperform bonds for the fourth straight year.

Extremely low borrowing and raw material costs, combined with weak currencies, are particularly beneficial for corporate earnings in the euro area and Japan.

Moreover, valuations in the two markets have become particularly attractive after the recent pullback, making them our most preferred equity markets.

However, diversification is a cornerstone of any disciplined investment strategy, especially given the heightened volatility.

Given this, one would be well served by a diversified basket of equities, income-generating assets (including bonds and high dividend-paying equities) and alternative strategies.

The relative resilience of such a basket through the recent market volatility has once again highlighted the benefits of such diversification.

  • The writer is chief investment strategist at Standard Chartered Bank's wealth management unit
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