We have not been surprised by continuing low interest rates, and expect to see this trend continue for some time. In fact, it would appear the European Central Bank is likely to finally come to the party and looks set to release their own form of money-printing to combine with their continuing ultra-low interest rates. This will have the predictable result of holding global asset values up, despite fundamental economic weakness. Even though we feel some markets are well overvalued (the US being one), that doesn’t mean continuing low interest rates won’t keep them there.
In Australia in 2014, the positive impact of low interest rates on the value of yield-based stocks (e.g. Banks, Telstra) has been offset by the falls in value of resources stocks. Our best guess is that the first trend will continue this year, albeit with slightly less upside, and the second trend will reverse. This should be positive overall for the Australian stock market over the year.
However, given our portfolio aims to deliver in all environments, we must ask ourselves and allow for, what else might happen. Broadly, we see two other alternatives in the year ahead. Volatility is likely to continue, and with it will come market fluctuations.
We are happy to take the risk of smaller market corrections in our stride, but are looking to put in place some limited portfolio protection against sustained stock market falls as we make further investments into equity markets. This won’t protect the portfolio totally, but will provide a buffer against the risk of market falls greater than 10%. Downside surprises could come from a lot of places in 2015, but most likely from places or events we haven’t thought of, the so-called unknown unknowns. Surprises after all, by their very nature, are a surprise!
The second alternative is that we could see markets perform better than expectations. The US economy is continuing to get better and Australia has been in the doldrums for quite a while. It is not inconceivable that our economy will, against popular expectation, improve substantially this year. While not our expected outcome, we have positioned the portfolio to continue to have a reasonable allocation to equity markets so that it can benefit from a greater than expected improvement.