10 Economists On 10 Asset Classes

European Equities

Is the European Central Bank (ECB) restoring investors' confidence in European securities and the economy?
The ECB is still undershooting its 2% inflation target—it's closer to 0.9%. But markets are responding to ECB policy. The euro is down, bond yields are down and equity markets are up. Part of the ECB's goal is to create stability and have no ambiguity in their messaging, which is very different from the US. The market is reacting more now to the ECB than the Federal Reserve.

Ultimately the ECB wants to restore confidence. What's important for them is intra-European trade between Germany and other countries, and that is recovering, partly in peripheral Europe in places like Italy and Spain.

Is quantitative easing working?
QE had a psychological effect on markets, particularly its immediate impact on FX markets. When it comes to lending, it's a more difficult game. But we're still in a situation where QE is effective, and I don't know why people would say otherwise. I think it will maintain low yields for bonds and for corporate bonds and high yield, and also create an immediate effect for the FX market. In equities, QE will have a future impact on sales and margins.

We're in a world where central banks are not controling the price of money but the quantity of money. We had three rounds of QE in the US and it worked. Some people said it had a decreasing marginal effect, but it did have an effect—it was most perceived when QE was stopped and you could see the changed levels of volatility.

What areas do you like right now?
The core market, including Germany, it still an area to look at. It's suffered last year over the summer through the industrial base companies, the export sectors, the car industries, and so for us Germany is still relevant.

Also the small and medium sized companies have proven to be rather resilient in periods where the market rushed for liquidity. That was one of the paradoxes of last summer where small and midcaps outperformed large caps. So we like Germany, the UK, French companies, the energy sector and health care.

Is Europe becoming a crowded trade?
It was a crowded trade in April, but it was partly deflated in June and was totally deflated in August, so now is an occasion to rebuild. Europe is more attractive than the US.

Is the long term story showing any obstacles?
The long term disadvantages in Europe are the debt burden and all factors pulling down total factor productivity and the eurozone dependence on emerging economies and the US. Those issues will continue to be a major long-term drag on growth. The trend growth in Europe is 1.5% at best, and it's higher in the US, at between 1.5% and 2%. Europe is a huge market, but with many issues still to tackle. There is a higher risk premium and there is a good reason behind that.

US Equities

How did US equities perform in 2015?
2015 stock price movements were dominated by the lower earnings estimates that were quite substantial during the year, and continue to be so. Since January, earnings estimates for the S&P 500 are down about 10%—around the same amount that stocks have fallen—and the primary reasons for the decline are the rise in the US dollar and the collapse in oil prices. The fall of emerging markets, the worries about China and global debt are also factors that have exacerbated that negative performance into the second half of the year.

Was the rise of the US dollar and the fall of oil a surprise?
Both trends were initiated at the end of last year, and analysts didn't react quickly enough to lower their earnings estimates based on those two factors. While the dollar has stabilised over the last six months, oil has not. The dollar is actually lower than it was in March but higher than it was a year ago, but oil is still lower. There was a second hit on oil that really undermined earnings in the materials, energy and some of the construction sectors, whereas the hit on the dollar was mostly exhausted by the first quarter of this year.

Do you think technology will continue to drive US equities to new highs?
Productivity growth has been extremely disappointing over the last three or four years. Certainly we have some leading firms like Apple and Google that are doing well. But there hasn't been that big breakthrough that has caused firms to want to spend a lot on information technology. Most of the improvements for firms have already taken place—email and Internet access and software are now already implemented. Technology now is just improving along the edges for these firms.

Would the S&P 500 or the Nasdaq be a safer choice for investors in 2016?
I absolutely think the S&P would be safer. The Nasdaq is expensive. Technology was driving the Nasdaq—certainly in the biotech sector. But I'm not saying technology is expensive overall. Apple is still a very reasonably priced company. I think value stocks, which are generally not part of the Nasdaq, have been ignored due to a fear of higher interest rates, and value stocks have been driven down more than is justified in reaction to those fears.

What's your 2016 forecast?
My feeling is that we could see 2200 or 2300 points on the S&P 500 at the end of 2016 [it's 2075 at time of writing]. I think we'll be hitting new highs. I'm looking for an upturn in productivity growth, and an elimination of those two strong head winds—the strong dollar and such low oil prices. If it weren't for those two factors' earnings, it would be up this year and so would the US market.

Emerging Markets

Were you surprised by the fall in emerging markets this year?
No—I'd be surprised if anyone was surprised—not if you create an economy which is close to 100% dependent on US dollar strength. We're talking about a global economy which is primarily driven by the US dollar being traded as a currency reserve, and as the US dollar strengthens during this cycle, you see that commodity prices have come off and the competitiveness of US dollar-based economies has deteriorated.

Since the great financial crisis started, we've issued $57 trillion in net terms worth of debt—and the bulk of it has been in US dollars. By virtue of this system we work under, when the US dollar goes up, of course everyone loses. Between September through December, prices have deteriorated as a result, particularly in emerging markets.

So what happens when the US dollar weakens?
The path of least resistance is that a weakening US dollar will re-engage interest from other countries to take on more cheap debt to boost their economies.

Meanwhile the Federal Reserve not only paused in hiking rates, but also seems to be looking in the wrong direction entirely as regards monetary policy. Over the last 100 years, when you had underperformance of inflation and of economic growth and the stock market was down, the Fed always looked to cut rates, not hike them.

I believe we'll see a gradual easing of the US dollar over the next year and that will accelerate as we come into 2017. There is a chance of reaching $105-107, but it's more likely we will trade $130 before we trade $100.

Where is value to be found?
Deep value is ready to be found in Russia, Korea, Brazil and Turkey. Having said that, there are more fundamentally less risky places like Mexico and Poland. As a more aggressive investor, I would be looking to take a small part of my risk across fixed income, currency and even equity in the first four countries.

Will the general EM bear market continue, and what are the influencing factors?
This rout has coincided with the commodity cycle since late 2010. If you look at year-over-year performance in EM, the only two years of negative performance were in 2015 and 2014.

China is another factor. People don't talk about the potential impact of the so-called Silk Road, the biggest fiscal and credit expansion package since the Marshall Plan after World War II. That impact is starting to kick off in countries like Pakistan and Kazakhstan and Turkey, and that will have a huge positive impact on the investment and infrastructure side of things.

Another factor is political instability, which we're putting too high a premium on. Maybe we should price it at fairer level, which could bring potential for relief in Brazil and Turkey, some of the countries that have been hurt the most.

Commodities

How did commodities perform this year?
Commodities had lost 20% of their value during 2015 when the year-to-date low was reached on 26 Aug., according to the S&P GSCI Spot Index and 56% since the peak in April 2011. Those are big movements by any standard, and many investors are asking if the bottom has been reached. We don't think we're there yet.

What's happening with the oil situation?
The price of US oil has been between $20 and $60 in today's prices in four out of every five months since 1870. The price periodically goes above that range—as it did during the China-inspired commodity boom that started in the early part of this century—but whenever it has previously come back down into the range, under the strain of higher supply and lower demand, it's invariably sunk to $20 and stayed low for some time. With this in mind, we foresee a price of $30 during 2016.

Do you see a similar story playing out for other commodities?
Yes. Copper dipped below $5,000 per ton during August, less than half of the $10,179 peak reached in February 2011. This may seem very low, but remember that the price didn't go above $5,000 until 2006 and had never been sustainably above $3,000 until 2004.

Expressing copper in real terms, using US CPI, shows it to be only marginally below the $5,580 average seen since 1957, expressed in today's prices. Cyclical lows during recent decades have been in the $2,000-$4,000 range, in today's prices, and we suspect $4,000 will be seen during 2016.

What about gold?
Gold is something of an exception: It has no practical use and remains well above historical norms in real terms. Gold peaked at $1,900 per oz. during 2011 but has since subsided, recently bottoming at $1,085 on 5 Aug. That 43% decline may seem a lot, but remember that gold had never durably gone above $600 in today's prices until the 1970s—though it should be remembered the price was fixed for much of the pre-1970 period.

In the decades since then, forays above $1,000 have been the exception rather than the rule. We expect to see gold below $1,000 during 2016 and to go substantially lower.

So you think the bear market has further to run next year?
We see the recent decline in commodity prices as part of the inevitable unwinding of an extraordinary bubble, a process that does not rely on negative outcomes in China. Many prices may have returned to "normal" but history suggests that's not enough.

China

How have Chinese equities performed this year?
I'm much less interested in the pullback that occurred in August or the Chinese government's reaction to it, compared to other investors. People have been hyperventilating due to the government intervention this summer, but did anyone forget that China is ruled by the Communist party? I don't think there is any intention from the Chinese government to relinquish control over its financial markets or its economy. These characteristics will remain for the foreseeable future and will survive anyone who is invested and alive today.

As for the magnitude of the correction, it didn't begin to compare with 2008. And why do people talk about that modest decline in July and August compared to the incredible run-up to that period?

Do you think China will perform well in 2016?
We don't make forecasts as such, but we're strong believers in valuation, and that's a good prediction of future returns. Valuations in China have not appeared to be an outlier either, from the perspective of developed or emerging markets.

That said, if we think of Chinese equities as different sets of opportunities rather than one single market, there are wide dispersions. What are cheap are the resources and energy sectors, particularly state-owned companies. But we see little evidence of a bargain relative to countries like the UK and Australia.

There are countries that are neither cheap nor rich but are sensibly priced, and that includes comfortably large emerging markets like China, South Korea and Taiwan. But I don't see these markets as either cheaper or more attractive than European equities, particularly in places like Italy or Germany.

What are your views on investing in Hong Kong and mainland Chinese equities?
With China, you're investing in the local economy, with a lot of governance issues attached.

Investing in Hong Kong-listed companies is a reasonable part of an investor's emerging market portfolio. As for A-shares, that I think has been and should remain the activity of very sophisticated investors with an understanding of the regulatory environment in China.

But surely we can't ignore China A-shares when they're about to be included in global indexes?
It's all very well for pension funds to get involved, but I think for retail investors, an ETF tracking A-shares is premature. With all that has happened this year, I think A-shares being included in global indexes might be a long way off.

Gold

What has driven the continued bear market in gold this year?
The bear market reached a new low in July at around $1,060 per ounce, and what's driving it this year as well as over the past few years is that investors don't see a need to hold gold as a safe haven. What really drives gold is problems with the US economy and the US financial system, and the US economy has been pretty good recently. We're seeing growth, unemployment is down and housing is on track. And the US dollar has been strengthening and is the first safe haven of choice.

When the US dollar breaks down, people go to gold. When something starts happening, whether it's geopolitical or financial risk, the world turns to the US dollar or US stocks. People are worried that volatility in China might lead to a global downturn in the rest of the world too, and they started losing confidence in what the Federal Reserve is doing. And when the US dollar is no longer a safe haven, investors turn to gold.

Can you explain the short term highs in the third quarter?
In August, people worried turmoil in China would lead to global contagion. In September, people got nervous, as the Fed decided not to raise rates after years of waiting. That led to a sell-off of the US dollar and that was good for gold. Since the July lows, we're seeing the market start to worry more about financial risk and tail risk, and that has enabled gold to move to short term highs.

What's your longer term view?
The long term is very unclear to me. The gold sector is very out of favour. The question is whether the recent strength of gold continues through the end of the year, or whether this is just another short rally. Are there truly elevated levels of financial risk for the longer term?

We're bullish on gold in the long term, however. Give me a one- to five-year view and I'm positive on gold, as there's still a lot of financial risk in the system as a result of various monetary policies around the world, with quantitative easing, etc. These policies will end badly at some point. Whether that starts happening in 2016 or 2020 is impossible to predict. But the bad result will be good for gold.

What is your recommended allocation to gold?
We recommend 5% to 10% in your portfolio, or whatever you're comfortable with. Within that allocation I include gold mining or gold shares, which have a high correlation to physical gold.

Do you view gold as a safe haven?
To me, gold is a hedge versus financial risk, and the source of that risk doesn't matter—so it's a hedge against inflation, deflation and currency turmoil: anything that creates elevated financial risk or tail risk.

Global Corporate Bonds

What were the catalysts for corporate bond prices to go down this year?
I think the drivers in the past were mainly the hunt for yield, and with that, bond prices did go down for quite some time. As the US talks about interest rate rises, corporate bonds didn't do so well, especially ones with older maturity buckets.

We have been in bubble territory, yields have been low compared to history given the default risk that is in there, and the bonds that will perform the best are probably still euro corporates where you have the hunt for yield.

Is the hunt for yield still having an effect on prices now?
The hunt for yield is definitely there, but now people are more cautious, at least with high yield bonds where spreads have widened. This is the case specifically in the US, where, with the oil price so low, quite a few high yield bonds are issued by fracking companies, so the risk is higher in the US than in Europe. US high yield is therefore still something to avoid at the moment due to its structural nature.

In the longer term, with the dollar more likely to rally than not, remember that many corporate bonds are denominated in US dollars, so it becomes harder for those companies to pay in US dollars if their currency weakens against the greenback. That scenario will depend on the company and whether they export a lot and where they get their income from. It also depends on when the Fed starts to hike rates.

Will the hunt-for-yield bubble continue next year?
Probably, yes. A few months ago we saw euro high yield going into bubble territory. One-year volatility was lower than gilts, and when I first saw that I thought there was a mistake in the data.

We've seen a bit of a correction, which is good, but there's still a hunt for yield, so it could go both ways, and investors need to be careful.

Where do you advise investing?
Allocate a small amount and usually on the shorter maturity end, as these bonds are less sensitive to rate hikes. You could definitely miss out on performance on the longer end of the curve. With the Fed not hiking rates when people thought they would, that means your interest rate risk comes down again; therefore, your overall spread comes down and your bond price goes up again and much more so for the longer dated ones. So it's not even just the credit spread, it's the interest rate part too that you must think about.

If you go to the shorter end of the risk spectrum, you could be at the wrong end of the curve, but at the moment it seems safer not to have too much interest rate risk in your portfolio. Buy and hold investors who are not rebalancing don't want too much risk. The Fed could raise rates by the end of the year.

Japan

What's your view on Japan?
Japanese equities have had a very good run since Shinzo Abe was elected in 2012, and the question is whether that's going to continue. First, the Abenomics plan has three arrows—and he's added at least two more—but the bulk of it is about short term policy stimulus and long term economic measures to stimulate growth, and all these measures have been positive for equity investors.

The bulk, if not all, of equity market gains since 2012 can be explained by soaring corporate profits, because they are earning in foreign currency and that's worth more in yen terms as their domestic currency is falling.

How has corporate governance been good for investors?
A lot of corporate governance is about greater openness, applying the same standards one would expect from a Western company and making sure there are clear, aligned interests of the company managers and the shareholders. We're seeing more long term share incentive schemes, and this is backed by a number of guidelines and by encouraging state bodies to focus their efforts on companies that meet the higher standards.

Japan's big problem is its adverse demographic, which means that the same number of people have to work incredibly hard to keep the economy at the same size. Abenomics is about boosting the sustainable growth rate, and it can do that partly by slowly increasing the workforce—getting more women and older people working and opening up the borders to immigration.

Will Japanese authorities' purchasing of equities and ETFs boost the stock market?
The government is putting the public's money where its mouth is both through pension funds and the action of the central bank. Ironically, as the price of equities has risen, pension funds no longer need to buy equities and are selling them a bit to maintain the right proportion of equities versus overall assets.

But there's certainly much more buying to come from the Bank of Japan. So far their QE programme has concentrated on the bond market, as it's large, liquid and has the advantage of keeping borrowing costs low. But there will come a point when this purchasing distorts bond prices even more than they're doing now and the BoJ will look instead to equity markets for QE.

What's your 2016 forecast?
It makes sense that the direction of Japanese equity markets and the yen would continue to diverge. They're both moved by the same factor—monetary policy. We forecast 140 USD/JPY and the Nikkei to reach 23,000 points from current levels of 18,554. That's against a backdrop where we expect US equity markets to be suffering.

What about investing in Japanese government bonds?
I don't know why anyone would want to own a JGB, as they yield less than 0.5% on 10 years. There are concerns about Japan's awful debt position, which is well over 200% of its GDP in growth terms, so bond investors will have to question the future solvency of the Japanese government.

Global Government Bonds

How have government bonds performed this year?
Yields on bonds from many developed nations are not far from the start of the year, in contrast to many analysts' predictions for increases. The European Central Bank has expanded its balance sheet and implemented negative interest rates, while the yield on 10-year German bunds is down 20 basis points from a year ago.

The yield on US Treasurys has moved only within a narrow range given the uncertainty of the Fed rate hike. Meanwhile, emerging markets and commodity exporters have seen much greater moves, with Brazil leading the way. Greece has also seen huge yield swings during 2015 as yields spiked on a potential Grexit and then dropped by nearly 350 basis points as markets ceased to widely anticipate a default.

Why are yields so low now?
Loose monetary policies, especially the accumulation of assets on central bank balance sheets, have lowered yields across the curve. Central banks in some developed markets are still buying assets to stimulate economic activity and promote some modest inflation. The net result, of course, is to anchor short term rates at or below zero. The Fed and the Bank of England may be the only central banks able to hike next year. Many countries are still battling disinflation.

What's your 2016 forecast?
We expect interest rates to rise gradually in the US, with the 10-year US Treasury note reaching 2.5% in 12 months' time. We believe that US GDP will expand beyond its potential growth rate of approximately 2% even after a recent slowdown. Given that inflation remains low—core PCE inflation in our view will stay well below 2% throughout the next year—these are attractive real yields.

We anticipate the short end of the Treasury curve to rise faster than the longer end as the Fed hikes interest rates for the first time in nine years. The potential for the Fed to decrease its current balance sheet will also weigh negatively on US rates. There may also be fiscal policy drivers, especially in the near term as Congress struggles to pass a full-year budget and lift the debt ceiling.

In the eurozone, we look for GDP to approach 2% annual expansion. Even though the ECB is likely to continue its balance sheet expansion, German bunds are likely to rise from their current lows to 1.2% in a year's time on incremental inflation. Even in Japan, where low rates have persisted for decades, we expect the 10-year JGB to rise to 0.6% in a year.

And what about spreads?
We believe spreads will contract going into 2016 as the ECB progresses with its QE programme and US investors take advantage of the more attractive yields on offer in the investment grade corporate bond market. Incipient global demand should put upward pressure on sovereign yields across the world.

Frontier Markets

How have frontier markets (FM) performed this year?
In short, FM performed rather badly in the first 10 months of 2015. We saw around minus 14% for the commonly used but geographically narrow and poorly designed MSCI Frontier Markets Index.

A major problem is the lack of sectoral diversification: Financial services accounts for nearly 55% of the flagship index, which drives investors to make highly concentrated bets on the banking sector.

Is it all doom and gloom in FM?
If approached properly, frontier market investments can indeed generate superior risk-adjusted returns over long investment horizons—think more than five years on average. But ultimately, if one cannot understand the underlying country risk dynamics and/or asset class and sectoral specificities, the investor should stay out of these markets.

What's the outlook for next year, and are there still certain FM or FM indexes you would not recommend?
I would definitely stay away from the MSCI FM Index and all the financial products that are based upon it, as the choice of countries and sectors composing the index is rather rudimentary: The underlying market-capitalization weighting scheme—which is partially flawed for Northern Hemisphere developed markets—is truly disastrous when it comes to emerging and frontier markets.

Also, I think one should want to avoid the whole greater MENA area including Turkey and the Caucasus area for the next 12 to 18 months, apart from Israel—an insulated advanced economy—Morocco, which has practically become an emerging market in its own right, and perhaps Oman, whose relatively diversified economic base, solid social infrastructure and secular ties with Britain, the Indian subcontinent and a resurgent Iran should shield it from the intensifying Gulf Cooperation Council (GCC) storm.

I would therefore stay away from both the iShares MSCI GCC ex-Saudi Arabia and its main rival from db X-trackers. Likewise for the country-specific Lyxor Kuwait ETF, which has the dubious distinction of combining a negative macroeconomic outlook, poor sectoral diversification and rapidly deteriorating country risk metrics.

What sectors and/or countries look the most promising?
Listed utilities, energy transportation, real estate and construction are four key sectors which should benefit from the steady rise in infrastructure investments across Asia, Latin America and Sub-Saharan Africa in the medium term, a trend encouraged by renewed regional and supranational interest in the asset class.

Equity indices in Southeastern Europe including Romania, Macedonia and Serbia are well positioned to deliver superior risk-adjusted returns in the coming years, in spite of the deteriorating country risk metrics in neighboring Greece, Turkey and Ukraine.

Likewise, the Greater Mekong area comprising Vietnam, Cambodia, Burma, Laos and Thailand (the latter being an emerging market), Central America and the West African Coastal area (led by Senegal and a resurgent Ivory Coast) should perform nicely in the next five years.