Of 2014 we can say many things, but boring is not one of them. Equity markets reached historic heights, bond markets sustained historically low interest rates, oil plunged and geopolitical turmoil made us all hold our breath. Through it all, domestic market indexes delivered attractive returns: the S&P 500 was up 13.69%, while investment grade bond markets gained 7.46%.
The question now is: What will 2015 bring?
The year has started with plenty of volatility, which should create more opportunities for active management. When dealing with dislocation and changing markets, active management becomes increasingly important for financial advisers as they strive to help clients seize the opportunities – and avoid the pitfalls – that inevitably arise.
(Related read: Optimism abounds for financial advice industry in 2015)
Legg Mason is built on a multi-affiliate model, where each asset management entity maintains independence across investment process and philosophy. Thus when we ask around in-house for predictions on the year ahead, we don't get one answer but several. Diversity of thought and action generates unique perspectives. They may not always agree, but that can be for the best.
Growth will be global, U.S. leading
Our Western Asset Management affiliate believes the global economy will continue to expand in 2015. Growth, if tepid, will be aided by improving private demand and accommodative central banks. The European Central Bank and the Bank of Japan will continue to ease monetary policy.
Even as the Fed moves to increase rates – probably later in the year – Western Asset expects monetary policy in the U.S. to remain very accommodative, with rates well below normal. This will provide impetus to solid growth, the best in the developed world, while also supporting financial markets. Broadening global growth will be favorable for many bond market sectors, including corporates, mortgages and emerging markets.
Long-dated U.S. Treasury bonds should also benefit from the muted inflationary environment Western Asset expects in 2015. With risks tilted towards inflation moving even further below the Fed's target, bond yields should continue to be low, thereby supporting bond prices.
(Also: Long-term investors can find opportunities in Europe and Asia)
Opportunity in emerging markets
Our other large global fixed income manager, Brandywine Global, believes higher-yielding local-currency emerging market debt will provide the most attractive values in 2015. In their view, G3 country interest rate hikes will be gradual and result in rates at very low levels, ultimately making higher yields in emerging markets too attractive for investors to dismiss.
Brandywine Global believes emerging market fundamentals are much improved from past crises. Investors can rely on stronger central bank credibility, deeper commitments to low inflation, larger forex reserves, ambitious structural reforms, greater reliance on local-currency debt, more liquid markets and greater institutional investment.
U.S. equities keep climbing
Our largest equity manager, ClearBridge Investments, notes that U.S. corporations have a record $1.65 trillion in cash on their balance sheets. How corporations allocate that cash and other capital assets should impact earnings, stock prices and value creation.
(More from Thomas Hoops: Closed-end funds can offer opportunities, despite risks)
ClearBridge Investments expects M&A activity to continue across most sectors. Healthy balance sheets and still-low payout ratios should also lead to solid dividend growth, extending Clearbridge's view of “The Golden Age of Dividends” that ClearBridge first recognized over a year ago.
As for small caps, the Royce & Associates team sees interesting opportunities ahead, particularly after the Russell 2000 Index saw its biggest correction since 2011 in the fall of 2014. More than one in 10 stocks in the small cap index are down 30% or more over the last 12 months, and Royce believes that many high-quality small-cap stocks are undervalued.
Europe facing a big year
QS Investors, our multi-asset affiliate, forecasts that if European economic growth continues to be anemic and inflation expectations continue to fall, the ECB may have to choose between a deflationary spiral similar to what Japan went through in the 1990s, or a more aggressive, full blown quantitative easing program.
To Martin Currie, our Scotland-based international equity manager, the disadvantages, pain and political impact of Europe's struggle to reform its economies and cost structure are well known. What is less appreciated – and likely not reflected in share prices – are the potential advantages that may accrue to companies doing business in that challenging environment. A more open-handed ECB, as well as the heavily promoted 300 billion Euro infrastructure fund and the declining euro, could add up to a solid 2015 for select European companies. This may reward prescient investors as improvements take hold toward the latter part of the year.
Don't forget Japan
The widening gap between equity and price-to-book value, present in Europe and parts of Asia, is especially widespread in Japan despite the country experiencing some of the best earnings and dividend growth in the developed world. To our ClearBridge Investment team, this fundamental improvement has yet to be discounted in Japanese share prices. With valuations among the lowest in the world, low expectations for improvements in profitability and growth set the scene for upside surprises.
To Permal, our alternatives manager, we are experiencing divergence of both economies and markets. These divergences of economic conditions will create many interesting trading opportunities in currencies, fixed income, country versus country from an equity standpoint, and even a particular country's equity market between winning and losing sectors.
So if nothing else, analysis of the year ahead from our seven affiliates proves that families – human or corporate – can agree to disagree. Those that do often learn from each other.
Just as our multi-affiliate model provides us with unique (and often differing!) investment perspectives, financial advisers should seek perspectives from multiple sources as they work with clients to develop and fine-tune the plans that will best meet their needs in the year ahead.
Thomas Hoops is executive vice president and head of business development at Legg Mason Global Asset Management.
