Introduction by Mark Haefele

World in transition

2015

2015 was a year in which major developed market equities initially rose 20%, then plunged 20%, and then finally rallied back again. How did you navigate the big waves? In such a market, even some of the world’s most respected fund managers tumbled into double-digit negative performance.

Almost every month brought “surprises.” Many things outside of our 2015 base case came to pass:

  • The oil market has still not cleared.
  • The Fed appeared to add global growth concerns as a reason not to move interest rates.
  • Greece got close to leaving the Eurozone.
  • China abruptly moved toward allowing the yuan to float freely.
  • The Swiss National Bank abandoned its 1.20 currency floor against the euro.
  • Far more Eurozone government bonds traded with yields in negative territory.
  • Second quarter saw a rapid bond market sell-off.
  • The Chinese equity bubble just kept going – until it didn't.
  • Volatility spiked to its highest levels since 2008.
  • Many thought Chinese growth was falling uncontrollably.
  • Emerging market currencies had a deep sell-off.

 

Getting the big things right

Surprises cannot be avoided – and that is the art and science of building a robust portfolio. First and foremost, a robust portfolio focuses on getting the bigger things right: strategic asset allocation and risk management.

In part, this means:

Accepting the unexpected.
At the start of 2015, the Swiss National Bank's decision to remove its currency cap against the euro came against our forecasts: we held an underweight position in the Swiss franc. However, our principle to limit the scale of tactical positions reduced the portfolio impact. Furthermore, our strategic decision to hedge portfolios against currency risk limited volatility for Swiss investors.

Staying true to your investment principles.
Through August, the relatively muted performance of high quality bonds proved frustrating against the backdrop of plunging equity markets. While we hold an underweight in government bonds, they still have role in di- versifying our strategic portfolios. This principle of diversifying again began helping performance by September.

Working your process.
With the sharp drop in equities through August and September, we reexamined our assumptions on the state of global growth, and concluded that “staying the course” through the volatility made sense. Working through an investment process fights the behavioral biases that often destroy performance.

A world in transition
For me, some of the most interesting things about 2016 are the transitions. The US faces a transition away from an era of zero interest rates/zero inflation, and we will learn the identity of Barrack Obama's successor.

With the constitutionality of European quantitative easing settled, Europe continues to transition as a political and economic bloc, which brings new challenges at every turn.

China is transitioning both from a manufacturing-led to a consumer-led economy, and from a state-directed, to a free market. Both will create uncertainty at times over its growth path and the outlook for capital flows.
Other emerging markets will need to find new growth drivers, and will likely be pressured by US interest rate hikes.

Investment view
We enter the year positioned with an investment view based on several predictions:

  • A modest acceleration in global growth will happen in 2016.
  • 2015 did not mark the peak of the cycle for risky assets.
  • China can both slow quickly, and avoid a hard landing.
  • We might be close to the bottom of the EM and commodity downturn.
  • Inflation will return, but not with destructive force.
  • The political elections will cause lots of drama but less tragedy in 2016.

Our key tactical positions for the Year Ahead include an overweight position in equities relative to government bonds, a regional preference for Eurozone and Japanese equities, and an overweight position to US investment grade credit.


2016 - A world in transition

For me, some of the most interesting things about 2016 are the transitions. The US faces a transition away from an era of zero interest rates/zero inflation, and we will learn the identity of Barack Obama's successor. With the constitutionality of European quantitative easing settled, Europe continues to transition as a political and economic bloc, which brings new challenges at every turn. China is transitioning both from a manufacturing-led to a consumer-led economy, and from a state-directed, to a free market. Both shifts will create uncertainty over China’s growth path and the outlook for capital flows. Other emerging markets will need to find new growth drivers, and will likely be pressured by US interest rate hikes.

Investment view

We enter the year positioned with an investment view based on several predictions:

  • A modest acceleration in global growth will happen in 2016.
  • 2015 did not mark the peak of the cycle for risky assets.
  • China can both slow quickly, and avoid a hard landing.
  • We might be close to the bottom of the EM and commodity downturn.
  • Inflation will return, but not with destructive force.
  • The political elections will cause lots of drama but less tragedy in 2016.

Our key tactical positions for the year ahead include an overweight position in equities relative to government bonds, a regional preference for Eurozone and Japanese equities, and an overweight position to US investment grade credit.

I wish you a healthy, successful, and interesting year ahead.

Ups or downs?


2015 - Rights and wrongs in brief

Right

  • US dollar vs euro: The European Central Bank extended its easing program, sending the EUR to a decade-low.
  • British pound vs Australian dollar. The GBP continued its appreciation in 2015, while the AUD suffered from weak Chinese commodity demand.
  • Underweight EM equities: EM equities underperformed in 2015, largely due to a decline in commodity prices and broadbased slowing in EM growth.

Wrong

  • Overweight Swiss equities suffered after the sudden strengthening of the Swiss franc affected the outlook for exporters.
  • Underweight Swiss franc was caught on the wrong side of the Swiss National Bank’s decision to stop intervening to weaken the franc.
  • Overweight US high yield credit fell short of expectations amid concern about the financial health of US-based oil drillers.

Up

Equities
Global growth
Inflation
US interest rates
Oil

Down

Government bonds
Euro interest rates

Mixed

The US dollar
The euro


 

Same again

Volatility