Such a change in sentiment marks an about-turn from the strong returns generated from financial assets during the first half of the year, which broadly saw gains delivered across most asset classes, albeit to the point where it was generally acknowledged that most financial assets had become mildly overvalued. Lower commodity and oil prices were of great help to the net majority of nations, not least the Eurozone bloc, which as a net energy importer saw a vast reduction in its cost base. As credit flowed to Southern European small and medium-sized firms, partly as a result of further quantitative easing from the European Central Bank to the tune of a planned €1.1trn, overall economic activity picked up markedly, supported by a depreciating euro. Events in Greece during the summer did little to disrupt progress elsewhere.
Financial assets linked to emerging markets and commodity producers, however, fared less well over the past twelve months; many assets associated with a slowing China were sold down indiscriminately in expectation of weaker demand, leading many Asian stocks to trade at excessively cheap valuations. The bursting of the bubble in overvalued local Chinese A-shares, and subsequent intervention by the Chinese authorities, did little to help regional sentiment. Events came to a head in late August as ‘Black Monday’ saw key global stock markets fall by over 5% on the day, marking a significant and violent move downwards. Since then, markets have broadly stabilised.
Turning to more positive factors, the finances of the US consumer have improved notably; sustained wage rises, lower gasoline prices, and a strengthening of the US housing market are likely to continue acting as an offsetting positive force for the global economy throughout the remainder of 2015. The British economy has also continued to generate consistent economic growth throughout the year. The surprise election of the Conservative party, perceived as a business-friendly outcome, led the FTSE 250 index of medium-sized UK shares to rally in expectation of improved long-term prospects.
The timing of the first increases in global interest rates continues to be a highly debated topic and will be heavily dependent on the strength of UK and US economic data. Divergences in the likely path of interest rates in key economies, coupled with a lack of clarity relating to near-term global growth prospects, imply that further volatility in financial markets may follow. In these market conditions, alternative assets such as Property, Hedge Funds and Absolute Returns funds contribute to portfolios by offering defensive characteristics and the potential for gains to be generated independently of global stock markets.
Commercial Property has been a solid performer in recent months, even as equities have wavered; the prospect of low interest rates for longer has led investors to view bricks and mortar as an increasingly attractive asset class given the reasonably high yields on offer compared to Cash and Bond markets.
We view the Asian region as fundamentally strong on a medium and long-term view; despite the well-publicised risks to the near-term growth outlook, the Chinese authorities still have $3.5 trillion of reserves that are likely to be applied to support economic progress and development. That said, some medicine will certainly have to be swallowed as the nation embarks on a path towards liberalising its capital markets.
With QE having been largely responsible for a degree of distortion to global asset prices, we expect a more normalised structure of financial returns going forwards; Fixed Income assets are likely to witness lower returns than higher risk assets on a long-term view, an outcome that has not been the case in recent years. We continue to take an underweight stance towards Bonds; the prospect of limited gains and the risk of capital losses continues to cast a shadow over prospects for the asset class. Instead, we continue to favour Absolute Returns funds.