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2015 will reward risk takers, says JP Morgan Asset Management

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Continued divergence in economic performance and monetary policy is the prevailing theme investors will have to grapple with in the year ahead, according to JP Morgan Asset Management’s Global Market Insights team.

New research “Worldview: Central banks, the dollar and investing in 2015,” argues that global central bank actions will be the primary drivers of market returns. Investors should expect volatility but a modest preference for stocks over bonds makes sense as long as policy makers continue to pursue stronger growth and higher inflation than the world economy is currently delivering.

 
“Both the US Federal Reserve and the Bank of England will likely raise rates in 2015 as their recoveries mature, whilst feeble growth and the risk of deflation will continue to threaten Japan and Europe. We see this in the chart below which shows different market expectations for target rate policy rates. There are both risks and advantages to this divergence but, for investors, it will have three implications: a stronger US dollar, continued weakness in global commodity prices and looser monetary conditions globally than previously expected,” says Stephanie Flanders, Chief Market Strategist, UK and Europe, JP Morgan Asset Management.
 
Although a stronger dollar will likely have an adverse impact on some regional equity markets, investors needn’t necessarily fear it, continued Flanders, as long as it remains reasonably orderly. A stronger dollar is a win-win situation for the global economy if it helps to sustain the US recovery and revives demand in the rest of the world. It becomes dangerous when it reflects a more dramatic divergence in the economic fortunes of the world’s most important economies,
 
“If a stronger US currency attracts international capital to dollar assets, investors will worry about the impact on emerging market performance. However, emerging markets’ stronger FX reserve positions and greater exchange rate flexibility leave them better poised than in past cycles, suggesting they can avert any currency crisis,” says Tai Hui, Chief Market Strategist, Asia, JP Morgan Asset Management.
 
“While monetary policy will remain extraordinarily loose globally, the path to normalisation in 2015 will begin in earnest with an interest rate rise in the US,  likely mid next year, assuming the US unemployment rate continues to fall faster than expected and wage growth picks up,” says David Kelly, Chief Global Strategist, JP Morgan Asset Management.
 
“When the US Federal Reserve finally gets going it will increase the Fed funds rate by no more than a quarter of a percentage point in any one meeting to keep the move to monetary neutrality smooth. They may ultimately want to ensure long-term rates stay above short-term rates, implying negative total returns along the entire Treasury yield curve for maturities of two years and above over the course of 2015. Consequently, 2015 should be a year to be underweight Treasuries and short duration in the United States, although bond markets outside the US may fare better,” continued Kelly.
 
The 2015 outlook currently looks more promising for global equities than fixed income. As shown in the chart below equity valuations still look reasonable by historical standards and in absolute terms. They also look attractive relative to inflation and interest rates.
 
The US will continue to lead the way, with earnings likely to grow at roughly mid-single digit pace in 2015, noted Kelly.
 
The macro picture is less clear cut for emerging market equities which remain hindered by the gradual slowing of Chinese growth, weakness among commodity producers, political drift away from free enterprise and the potential impact of higher US interest rates. However, Kelly argues that given a faster pace of economic growth, emerging market earnings should have strong long-term growth potential and valuations do not look extended.
 
“The fundamental rule in investing that has applied over the past five years still applies to the investment environment as we enter 2015: when cash pays you nothing it is time to get invested in something. The bottom line is that this is still a world that rewards risk takers,” says Kelly.
 

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