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Looking into 2016 with Hermes As we come to the end of 2015, it may feel as if it were a year of turmoil, with volatility increasing, worries about the end of the liquidity cycle surfacing and the (surprisingly) sudden realisation by investors that Chinese growth cannot continue on a trajectory of 7% forever creating much soul searching. However, in terms of stock market moves, the year looks to be ending on a marginally negative note, with a muted decline from the peak of the Shanghai index in June. This makes predictions for 2016 all the more difficult. Nevertheless, there are some key factors a long-term investor can rely on: Interest rates will rise from current levels, with the tightening
starting in the US and followed in a staggered fashion by the UK and eventually Europe. This combined with reasonable economic growth in the US (the largest global economy) and in China (4-5% growth is still substantial for the second biggest global economy) should make for a constructive case for equities;
The world’s temperature has passed through the +1 degree level
and looks set to go through the +2 degree level. Whatever decisions come out of the Climate Summit in Paris, future valuations of all assets have to adjust for a carbon discount;
The barbarity of the atrocity in Paris, which brought the kind of
murder ISIL has been inflicting on Muslims in the Middle East for two years to developed economies, along with Russia’s adventurism in the Ukraine, underlines that political risk is likely to play a much larger role in investment thinking over the next decade than it did in the preceding decade.
Saker Nusseibeh Chief Executive, Hermes Investment Management
RISK As the tide recedes on market risk, sharp rocks are slowly being revealed. It will be possible to navigate around them, but only with careful portfolio management. Risk manifests itself in several different forms – no single metric will give a complete picture – but we can highlight a handful of areas of potential vulnerability:
Risk of contagion is on the rise and portfolios may appear more diversified than they actually are. Financial markets are inherently unstable and represent a challenge for even the fittest-for-purpose risk models – we must be aware of their limitations and the potential pitfalls into which our portfolios might be led.
Volatility has been on the rise and markets are likely to see further
Eoin Murray Head of the Investment Office
and more severe spikes in volatility in 2016;
Some decoupling between credit markets and equities has taken
place and we expect that to continue, but the risk that correlations all rise together across asset classes is very real;
Liquidity risks remain most prevalent in the credit market, but there
are genuine dangers of spillover to other markets in the event of financial stress; and lastly,
We expect markets to remain fragile and vulnerable to shocks.
MACROECONOMIC We are still expecting baby steps toward policy exits, as central banks with ‘skin in the game’ avoid taking the market off-guard. My outlook revolves around four beliefs.
Third, China is slowing, but has the ability to soften the landing. The effects on leverage and deflation need to be watched, but the Fed may not be knocked off course.
First, US and UK real policy rates will stay negative into 2017 and ‘peak’ rates will be much lower than we are used to. Eight years after the first traces of crisis, we have moved to a two-speed recovery. In the lead are the US, Canada, Australia, New Zealand and, for the first time, the UK. But in the slow lane are Japan, the eurozone and some emerging markets. The eurozone will continue to lack fiscal union. Greece may restructure, but this will likely b