How to play the market in 2015

Offshore industrial, consumer and construction stocks, coupled with local high-yield shares, should be on the menu.

Summary: Global equities are still the place to be in the year ahead, but diversification is essential. The US stock market doesn’t look overvalued despite hitting new records and if the Fed hikes rates it won’t dereail the US bull run. The ECB is set to print money, which will boost sentiment to European stocks. Volatility could be extreme, so buy on weakness.

Key take-out: My preference remains with US stocks, followed by Europe and select emerging markets. Domestically, take a medium-term view and see falls in the Australian market as a great long-term opportunity.

Key beneficiaries: General investors. Category: Strategy.

Despite what will be a very positive global economic growth – and an extremely benign economic – backdrop, it’s likely to be a tough year for investors in 2015. 

A major reason for that is because it is politics, not fundamentals, that dominate the landscape. From the decision of central banks to print – and indeed how other central banks (such as the RBA) respond to that – to the slump in crude and other commodities. In nearly every case, moves are driven by forces outside of supply and demand. For instance, and in the case of oil, the decision of some OPEC oil producers (the Saudis etc) to price out US shale producers.

Another example of how politics can absolutely blindside investors is the apparently random and completely unexpected decision of the Swiss National Bank to drop its currency cap against the euro – a move which led to a sharp spike in the Swiss franc against the euro. What’s more, the Swiss stock market plunged 10% on that decision. Many investors would have been burned.

On the domestic front – and in addition to the slump in commodity prices and the decision of the government and the RBA to try and weaken the dollar etc – regulators are a major source of angst to investors in the financial sector. How much of a regulatory crunch can banks and investors expect? No one knows for sure, it’s arbitrary – and local bank stocks have already suffered as a result.

Unfortunately, we can’t expect any clarity into 2015. Which for my money means that global equities are the place to be in the year ahead. Readers may recall that I first recommended domestics investors head offshore back in 2012  – and that has been a very profitable strategy (see Carr’s Call: Go offshore for better upside, December 7, 2012).

Now in early 2015 I’m suggesting you stick with that strategy, although the Swiss decision highlights why diversification is essential.

My preference at the moment remains with US stocks, followed by Europe (and the UK) and then select emerging markets especially those in Asia – India, China etc.

Here are the key points:

· Markets are becoming even more US-centric. The US has emerged from the crisis as a growth leader in the developed world. US markets will continue to attract investor capital.

· The US stock market doesn’t look especially rich or overvalued despite hitting new records.

· A Fed rate hike – if that does happen – won’t derail the US bull run. It didn’t back in 2004 and it won’t do it this time… especially as rates will remain exceptionally low. 

· The ECB is expected to begin aggressive money printing this year. This will boost sentiment toward European stocks, despite weak growth.

· Moreover, the weak euro will buttress European markets, especially the German market.

· Concerns about Russia and Greece are a key headwind and will likely prove a key source of volatility.

· This volatility should be viewed as a buying opportunity, however, for those investors who can take a medium- to long-term view.

Global construction should continue to rise in 2015, perhaps strongly, and so this remains a key sectoral pick, alongside the US consumer and industrial sectors.

Volatility could be extreme. Highly positive economic fundamentals mean that investors should buy on weakness.

Domestic equities

Now, while I think being overweight global stocks is the way to go, the risk remains that domestic equities could outperform. In the interests of disclosure, that was my expectation in the 2H14 – clearly I was wrong. Yet it wouldn’t take much for the Aussie market to put on a solid performance. I’m very cautious though as four key factors are weighing on domestic equities:

· The commodity rout

· Fear and uncertainty in the banking sector – related to regulation

· The slump in the AUD

· Very weak sentiment – a sell Australia message from our policy makers, politicians and many economic commentators.

The problem we’ve got though is that there is no certainty on any of the above points. Commodities could just as easily rally as slump further – fundamentals aren’t driving things here. Same with the AUD – and as for the other two points, that’s up to policy makers.

With all that in mind, I think investors need to be patient. Australia’s economic fundamentals are very strong. The record increase in employment growth in the December quarter really firms up my view on that. What I’ve been wrong on is the persistence of this “sentiment recession” that we have been enduring. My big concern is that if sentiment doesn’t improve, then Australia’s above-trend growth may slip, temporarily, this year – and that will weigh on stocks. All the evidence so far suggests growth is accelerating, but it’s early days and Aussie economic data is far from reliable.

I would encourage investors to look through the economic noise though. Take a medium-term view and – to the extent that the rest of our market gets dragged down by ongoing commodity price weakness etc – investors should view that as a great long-term investing opportunity.

Especially as the Aussie equity market is currently cheap on both a trailing and forward price-earnings basis. One key point to remember when investing in the equity market, is that traditional measures of value are less relevant. Or at least they must be augmented by this ultra-low interest rate environment that we live in to have any meaning.

In other words we should expect valuations to rise strongly into over-bought or expensive territory. That the Aussie market is nowhere near that suggests relative cheapness.

With all of that in mind, against all that uncertainty, high-yielding equities and defensives will likely retain strong support again in 2015. Expensive doesn’t come into yet – and within that, banks are set to remain a key medium-term outperformer, with both a yield and cyclical growth story attached.