This week saw 2014 come to a close. Given the interrupted market schedules these past two weeks, volumes and decisive investing action were nowhere to be found. Not surprisingly, year-end tax trades dominated what little flows occurred. Major asset allocators will be back in their seats starting next week and we will see what rebalancing will be on their minds. After the window-dressing at the end of the year, will they start the process of selling last year’s “winners” (US equity, technology, healthcare, US long-duration bonds, etc) and start buying back some of last year’s “losers” (most currencies other than US Dollar, emerging markets equity, commodities, energy equity, etc)? The sustained trend of US economic resilience and asset performance over the rest of the world has continued to stretch not only the gap between total returns over an extended period, but also their valuations. For example, the difference between the S&P 500 total return and the rest of the world’s equity markets (MSCI ACWI ex-US total return) has been about 10% per year for each of the last 5 years! Looking towards 2015, the price-to-earnings multiple on the S&P 500 is around 16x compared to 12x for the rest of the world. If you zoom in on an area like Asia ex-Japan (MSCI Asia ex-Japan), the price-to-earnings ratio is closer to 10-11x. This is justifiable in a backwards looking context given the difference in corporate performance between the regions, but at some point the pessimism reflected in valuations will be greater than the likely future making the rest of the world look too good to pass up.
The world remains a complicated place going into 2015. For the first time in a while, the purchasing manager index (PMI) of the manufacturing activity in China fell below 50 which means it contracted in the most recent period. In Europe, private sector credit continued to contract year-over-year (-0.9%) though it trended better than the prior reading. Adding to the challenge is the put-up-or-shut-up moment for the ECB on quantitative easing on January 22nd and the political disarray in Greece which leaves open the tail risk of a Greek exit from the Euro-area depending on the outcome of the election on January 25th. In the largest Latin American market (Brazil), Dilma Rousseff was sworn into a second Presidential term as the state champion Petrobras struggles with corruption and the currency hovers around 2.70 BRL per USD in a signal that economic conditions require attention. Despite an imbalance of supply/demand of around 1.6% (1.5mm barrels on global demand around 93mm), global oil prices have fallen close to 60% causing geopolitical uncertainty (Russia, Libya, Nigeria, Iran) and deflationary pressures in Europe. Later this year, it is the expectation that the Fed will be increasing rates for the first time in several years. After such a long time of a flat line near zero, any twitch of rates higher may cause a little concern. Of course, the market tends to climb these “walls of worry” and that has been true thus far. Chinese equity markets are closed through January 5th, but the day the weak PMI number came out the index rallied 2%. The EUR/USD exchange rate has fallen near 1.20 in confidence that Draghi’s action will be sufficient. We remain positioned for a 2015 that will continue to see global economic progress but remain vigilant of the many factors that hang in the balance.