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The trends are your friends in 2015

Growing Asian middle class: Shoppers enter a Burberry Group store in Beijing, China

In 2015 the new normal seems to be extreme market volatility. Already, the first few weeks of this year have seen big day-to-day swings in securities prices and major shocks to foreign currencies. The Chicago Board Options Exchange Volatility Index (VIX) has now shot up to a level about 36 per cent higher than last year’s average. Just last Tuesday, the Dow Jones Industrial average took a wild 400 point ride, first up 280 points, then down 120 points before closing down modestly on the day.

While we believe markets will see more of the same manic-depressive behaviour for awhile longer, we remain overall positive, especially for key themes likely to continuing playing out in the months ahead. In particular, we favour many of the same regions and sectors which worked well in the recent past. Patient investors will likely be rewarded by participating in solid investment themes and using market setbacks as opportunities to increase positions.

Market watchers may recall last year’s global economic and financial market volatility which also began early on. In January of last year, risk markets got off to a rocky start with the benchmark S&P 500 stock index falling 3.5 per cent in the first month of the 2014 as geopolitical turmoil took centre stage. Developed nations were caught off guard when Russia took aim at a floundering Ukraine, ultimately annexing Crimea. This event together with other aggressions led to progressively tighter sanctions against the Russian Federation culminating in an intense and as yet unresolved conflict, now referred to as ‘Cold War Light’.

Other disruptive events during the course of 2014 included the rise of the Islamic State in the Middle East, the Ebola health scare and a sharp drop in commodities prices, led by oil in the second half of the year. But still, equity market averages completed the year with respectable gains. The S&P 500 stock index advanced over 11 per cent in 2014, after hitting numerous new all-time high levels.

A slightly different set of circumstances is unfolding this year but the pattern of volatility is similar. This year, equity prices appear to be struggling between optimism over lower energy prices which should benefit consumers and thereby stoke the economy against the notion of relatively high equity valuations in the face of decelerating global growth. Further uncertainty surrounds the Eurozone and many questions regarding further monetary policy stimulus. Moreover, Greek politics, like a bad movie sequel, has been pummelling European bourses as investors worry that the troubled nation will eventually leave the euro zone complex, potentially sending the fragile region into further upheaval.

On strategic basis, we see little need to adjust our baseline investment themes for year ahead. While we do expect to see ongoing market volatility, this may not entirely be a bad thing. In the words of Warren Buffett “volatility is the friend of the long-term investor”. That’s because market setbacks often provide opportunities for patient investors to find rare bargains in high quality securities.

Key themes we see continuing to play out include ongoing US market leadership, the ageing of the OECD, widespread secular disinflation, the rising emerging market middle class consumer, ubiquitous mobile connectivity and the trend of income-earnings assets being better bid.

In 2014, the US trumped most other markets as the world’s largest economy led global growth. We expect this development to continue as the US remains “the best house in a tough neighbourhood”. Increasing domestic energy production, a propensity for innovation and the country’s manufacturing renaissance are important drivers helping America to prosper while geopolitical disruption crimps growth across many other regions.

Another ongoing trend is the ageing of the developed world population. Older people are clearly the fastest growing segment of the world’s largest economies and their needs and spending patterns are quite different from younger folk. On a global basis, the number of elderly is expected to increase each year to more than two billion by 2050 as people are simply living longer. In addition, the so-called baby-boomers are now turning 65 at the rate of 8,000 per day. This powerful demographic trend, together with a sharp decline in uninsured Americans under ObamaCare bodes well for the healthcare sector.

Fixed-income markets finished 2014 on a high note and while we remain constructive on bonds, now it is more important to be more selective and opportunistic. We expect the end of American quantitative easing (QE) last year to continue being replaced by foreign buying as overseas interest rates remain substantially lower. Europe and Japan are keeping their interest rates even lower than the US as these regions more forward with further monetary stimulus including QE.

Likely, 2015 will be the year that America’s Federal Reserve finally raises short term interest rates, but we do not anticipate dramatic moves that whack all bond prices across the ‘curve’. Rate moves this year are likely to be measured and very well communicated, probably beginning around midyear. In terms of fixed income security selection, we see the recent increase in relative interest rates differentials, or ‘spread widening’ of corporate bonds over similar government-backed issues as an opportunity.

With oil prices being cut in half since last summer, many smaller energy resource companies will run into debt-servicing trouble and some may default, but that has led to an unreasonable flight from corporate bonds as a group. Higher quality energy companies with low debt levels as well as many other industrial and financial sector credits are being thrown out with the proverbial bathwater. Credit spreads, trading at their highest levels since September 2012, are attractive.

In terms of commodities prices, we see a tricky period ahead, especially for the first half of this year. Faltering global growth, the slowdown and challenging transformation of China’s debt-laden economy, and strengthening of the greenback all present commodities headwinds. Notwithstanding a rebound from what may be oversold conditions today, the present economic backdrop favours the buyers of commodities over the producers. Transportation and consumer stocks are poised to benefit from the windfall of lower energy prices.

History shows that it pays for investors to stay far sighted and focused on longer term objectives when developing and executing an investment strategy. Staying with the trends that are working should be a key ingredient.

Bryan Dooley, CFA is a senior portfolio manager at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information.

This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.