Investors are set for a wild and woolly market ride

Australian investors with a long-term view would do well to navigate international waters for opportunities, but they'll have to withstand volatility in the near term.

The wild swings in markets over the past week that savaged the Canadian dollar, elevated the Swiss franc and roiled other currencies including the Aussie are just a preview of what’s in store for the new year. Volatility will become the new normal.

Central banks are grappling with vastly different sets of problems that are the consequences of bailing out the global economy from the last crisis. The US Federal Reserve will likely start to shift rates above nothing as the recovery becomes sustainable, albeit at the risk of stoking further strength in the greenback.

The European Central Bank, on the other hand, is about to embark on its most dramatic economic stimulus to date to resuscitate the eurozone economy and fend off deflation, after announcing a 60 billion per month bond-buying program overnight.

Economies are set on wildly divergent paths that are dictating differing paths for monetary policy. The oil price collapse adds another layer of complexity, hitting countries that are net exporters of petroleum (Canada) but providing an unexpected source of stimulus to net importers (Australia).

The Canadian central bank, in explaining its shock cut in benchmark interest rates to 0.75 per cent, said the oil price drop is “unambiguously negative” for the economy. Canada is the biggest oil exporter in the G7.

The Bank of Canada judged that the risk of fuelling overheated housing markets was secondary to the need to support falling incomes and inflation as a result of oil.

Investors were quick to draw a parallel with the Reserve Bank of Australia, betting on an increased chance of an interest rate cut here. Futures markets lifted the odds of a February cut to more than 30 per cent after Canada’s move, from less than 10 per cent a few days earlier.

But the parallel was false. While the slide in oil prices will cut income for Canadian exporters, it will conversely boost Australian economic growth and act as a tonic for Australians who will pay less to import fuel. Virgin Australia bowed to consumer pressure to drop its fuel surcharge on Thursday.

Just how all this will play out for equity markets in 2015 is any analyst’s guess right now. Yet with more than 50 per cent of worldwide government bonds offering a yield of just 1 per cent or less, some believe that equities will continue to lure investors searching for growth.

Boutique fund manager K2 Asset Management says that domestic investors are missing out on opportunities by not investing internationally.

K2’s chief investment officer Mark Newman says earnings growth will continue to lift US stocks and, notwithstanding a five-year bull run, notes that the S&P 500’s current price earnings ratio is only slightly ahead of the long-term average at 16.3. He also expects a catch-up trade in Europe as US-based investors look for bargains, and continued solid growth in Asia.

Australian investors will receive a strong tailwind from the falling Aussie dollar if they invest offshore on an unhedged basis, Newman says, although given the slide from $1.07 to 82 US cents much of this benefit may already be over.

But with the resources-heavy local market likely to continue to underperform relative to overseas markets, investors looking for growth need to diversify offshore, where global equities are forecast to deliver low double-digit returns, Newman believes.

Economists expect growth in Asia of up to 6 per cent this year, with the US tipped to finally produce sustained above-trend growth of around 3.8 per cent. The euro area will be lucky to scrape through with 1-2 per cent growth, even after the stimulus.

It’s certainly the case that Australians tend to be insular in their investments, with a heavy home bias towards local equities. Self-managed super funds, which have about one-third of the nation’s $1.9 trillion super savings, hold around 1.5 per cent in international equities versus 40 per cent in the local market.

By contrast, a diversified super fund would typically invest 30 per cent in local equities and 25 per cent offshore. Other G20 nations have cut their home bias sharply in recent years.

Whether this is the right time to start to navigate international waters depends on whether investors have a strong constitution and a long-term view. There will certainly be islands of opportunity, but it will be a wild and woolly ride in the near term.