We believe that markets will behave as they did in 2014, with periods of increased volatility corresponding with the eventual rise in US interest rates, European growth data and global geopolitical events.
Investors should therefore be focused on less volatile stocks that pay higher and stable dividends.
With Europe about to embark on an American Style bond buying program, European markets should see healthy inflows across equity and fixed income asset classes.
Why?
Exasperated by the recent drop in energy and commodity prices across the Eurozone, the 19 member union experienced deflation for the first time since 2009, increasing pressure on the European Central Bank to loosen monetary policy.
An announcement on 7 January then revealed that inflation turned negative by 0.2 percent over the previous twelve months.
As wages remain constant across developed economies, combined with the large drop in energy, agriculture, metal, fertilizer and transportation costs, consumers should begin to see an increase in disposable income, but only in the medium term.
It will take time for companies to pass through these lower commodity prices into the consumers’ pockets, and therefore in the short term this will only increase companies’ underlying commercial strength.
Once competition picks up, corporates will have to lower prices or risk losing market share to lower margin providers.
With the ECB ready to pull the trigger on its new Quantitative Easing program, European stocks should see an increase in demand from global investors, similar to what was seen over the previous rounds of bond buying by the United States Federal Reserve.
Of course this global drop in commodity prices will affect countries differently. Oil prices have fallen by over 40% in the last three months, and are down by over 60% from their peak back in 2009.
Consequently, gasoline prices have also fallen – a gallon of gasoline in the United States was as high as $4 in 2014 and now is just under $2. In Europe, that same gallon has fallen from a high of over $8 and is now closer to $6. One of the main reasons for the difference is the tax that European countries place on retail gasoline prices.
Transportation
Because of this drop in energy prices, transportation costs have fallen dramatically as well, as represented by the Baltic Dry Index. The cost of transporting goods by container ship has fallen by over 50% in the past year. That means shipping Iron ore from Australia to China in order to make steel, shipping iPhones from China to California, or sending a ship full of Toyotas from Japan to Mumbai just became a lot cheaper. We expect that this will benefit the global economy, but only in the medium term.
