Risk factors to watch out for in 2015: UK Investors
While there are many reasons for why UK investors could be forgiven for thinking that 2015 could be a good year for portfolio returns, we caution that there are a number of risk factors that will require careful assessment ahead of, and throughout the year.
Below we detail some of the most prominent risks which we believe UK investors will face throughout the year.
For further, or more detailed, information relating to our outlook for key and individual geographic areas, please see the our macroeconomic commentary section for the relevant region.
Risk factors to watch out for in 2015: UK Investors
UK General election to form the dominant theme for UK investors from a risk perspective
Chief among the risks to UK investors in 2015 is the uncertain outcome of a general election in May. Throughout recent months opinion polls have swung violently from a Labour majority to a Tory majority, and then onto a tie break with barely any difference between support for either party.
The fact that a Labour and Tory coalition would be close to impossible is what makes the likely outcome of the election so uncertain.
On the one hand there is the potential for Labour to steal a parliamentary majority with the Scottish National Party / Labour coalition, which would have negative connotations for markets. While on the other hand there is the potential for a Tory Party / UKIP coalition, which would also have consequences for markets.
Regardless of the outcome of the election, the one thing that is certain in relation to the UK economy is that the first half of the year will be plagued with uncertainty.
From concerns over the fiscal profligacy of any Labour government or Labour coalition to concern over deep spending cuts and the impact upon growth of austerity measures under a Tory government or Tory dominated coalition.
Such factors have the potential to damage confidence and deter investment throughout the early stages of 2015, and potentially onwards from here as well. Therefore, it is quite likely that growth will slip during H1 2015, which could also lead to an adverse outcome for markets and portfolio returns during the period.
Furthermore, concerns over the ramifications of a government comprised of mainstream parties ignore the potential implications, and economic impact, of any form of UKIP coalition that could come to power in 2015.
Consequently, we caution that the 2015 general election will be be a dominating theme for investors throughout the first half of the year as a minimum, while the potential exists for the outcome to have much larger, and more far reaching consequences.
Fiscal deficit, budget cuts and austerity could constrain growth in the UK
Another key risk for UK investors as we head into the new year is the need for greater fiscal tightening across both the UK and Europe, which could also have a further adverse effect upon the respective economies and financial markets.
In detail, the UK budget deficit is still close to 5% of GDP, which means that the government remains a long way off from the point where it will be able to begin reducing the nation’s debt in a meaningful way.
As a result, the Chancellor is likely to take time provided by any potential Tory re-election to cut deeper and harder into the state budget for welfare spending and public services, which could have a detrimental effect upon growth. At the very least, business investment and consumer demand would have a long way to go in order for them to make up the relevant shortfall.
In addition to this, there is still much work to be done both at the core, as well as on the periphery of Europe.
With France failing to satisfy the European Commission with its draft 2015 budget in October, there are wide expectations that the Commission could instruct the nation to make further cuts in 2015. This would be likely to have a negative impact upon the state heavy French economy, while also fuelling the fire in another key risk area; European politics.
If the French government is forced to make deeper cuts to spending then it is possible that support for Marine Le Pen and her socialist Front National party will grow. This would be an adverse outcome for investors as one of Le Pen’s core political objectives is to withdraw France from Europe. She currently holds 25% of the French vote.
“I want to destroy the EU, not Europe! I believe in a Europe of nation-states. I believe in Airbus and Ariane, in a Europe based on cooperation. But I don’t want this European Soviet Union”. – Marine Le Pen, speaking with Germany’s Spiegel Online
Outside of the realms of North European politics, the requirement for further austerity on the periphery could also have a destabilising economic and political influence, most notably across Italy and Greece.
All in all, the 2015 year is likely to demand further spending cuts from many governments across Europe, which feeds directly into our next key risk theme; political risk in Europe.
European political risk and economic weakness are to represent an increased threat to markets
At the heart of this European risk theme (econ weakness and political uncertainty) is the requirement upon both core and peripheral nations to further deleverage sovereign balance sheets during the year ahead.
In a low growth environment, characterised by high unemployment and weak domestic demand; experience has shown that the requisite austerity measures offer greater immediate benefits to right wing populist parties than they do to the actual economy.
While private consumption has shown some signs that a rebound is under-way during Q3 and Q4, the overall trajectory of the European economy remains toward the downside and with government consumption, investment and total domestic demand still falling; it is likely that overall growth will be lower in the coming quarters than at the same time in previous years.
As has been highlighted by recent events in Greece, economic weakness and speak of further austerity feed directly into the fires of political risk and uncertainty. This, even a considerable time after the darkest days of the debt crisis, can still pose a threat to portfolio returns.
While we see scope for positive performance in European equity markets during 2015, we also see uncertainties emanating from Greece, France, Italy and the UK as posing a significant risk to returns.
Further from here we also see scope for a further deterioration in Russia / West relations as the lower rouble impacts further upon domestic inflation and therefore, real terms consumer spending. The potential for a retaliation from Russia could also escalate the economic impact of existing sanctions for both the Russian and European economies.
Divergent monetary policy will also form a dominant theme for investors in developed markets
Following a year which has seen the US and UK economic rebound accelerate rapidly, two of the world’s major central banks are now on the verge of tightening monetary policy for the first time since before the financial crisis.
This is while three more of the world’s major central banks look set to either ease further, or to keep policy settings on a loose footing for the foreseeable future.
The net effect of this evolution in developed and emerging market monetary policies is the creation of another 2015 key theme for investors; divergence.
In particular, the ECB is widely expected to embark upon its own quantitative easing program in H1 of the new year, while the Bank of Japan continues with its own record program of monetary easing and the Chinese central bank also maintains a dovish bias.
When contrasted against a backdrop of tightening policy in the US and potentially the UK as well, the 2015 year appears to offer scope for increasing levels of volatility and divergent price levels to provide opportunity for stock pickers. However, there are also risks to this scenario as well, not least of all among them; the volatility itself.
Furthermore, the Federal Reserve has previously acknowledged that its overly cautious approach in raising rates between 2004 & 2006 had contributed to the creation of bubble like conditions in both the housing market as well as in financial markets.
With this in mind it is possible to say that when the FOMC does make its first move, that it may hike rates faster and further than the market currently anticipates.
Should this prove to be the case then equity markets, particularly those in the US, could become unseated from their current “close to record high” levels; which could harm portfolio returns for the period.
All in all, while 2015 may offer opportunity for stock pickers with a top down focus and stringent selection practices, monetary policies could also pose a risk to investors this time around; most notably those who are holding out for another “market-wide” repeat of 2013 or 2014 returns.
Although the prospect of this has reduced, a hard landing in China remains a risk that must be acknowledged
Concerns over the Chinese economy have receded somewhat since late November, when the People’s Bank of China cut rates for the first time in over two years.
This, combined with targeted liquidity injections, appear to have been a sufficient enough demonstration of policy maker’s will to act should the economic situation deteriorate to a level that warrants intervention.
We also believe that this display of reassurance from the Chinese central bank is the only reason for why the market reaction was so benign when Chinese economic indicators embarked upon a broad based downturn during December.
This downturn saw inflation and industrial production growth slip considerably, while the HSBC Flash Manufacturing PMI fell back into contraction territory for the first time since the beginning of the year.
On balance we see more flex in Chinese rates, which for a slowing economy and in comparison to the developed world, remain relatively high. While the economy will, without doubt, slow further during 2015; this flex should enable the central bank to contain the worst of the fallout with further rate cuts and targeted stimulus.
For this reason we are less concerned over the economy today than we were six month ago however; the financial system, as well as corporate & institutional balance sheets, remain opaque. This poses a risk to investors for two reasons.
First and foremost, as the economy slows further it is possible that loan delinquencies will increase in volume, which could prompt further defaults and insolvencies. While the Chinese government will likely resolve to intervene in order to shore up local confidence in the system under such a scenario, there could be some spillover here into international markets. This would most likely be in the form of a market panic over the potential for a shock to global confidence, contagion of unstable conditions or some form of credit crunch, that could lead to fears of a Chinese financial crisis.
Secondly, further reductions to interest rates could lead to further adverse outcomes in the property market and among institutional balance sheets. While this would likely be a longer term factor, China has struggled to contain property price rises in many urban areas for a quite some time now.
The interest rate trajectory could give false hope to property investors and lead to overinvestment in an area where returns are likely to be low or negative for the foreseeable future. Not only is this an unproductive or wasteful practice for the economy, but it could also help to build further risk in the financial system over the medium term.
As a result, while risks have diminished marginally throughout recent weeks, potential for a hard landing in China still exists. For this reason, it is a 2015 risk that must also be acknowledged by investors.
The contents of this report and the Stockatonia website (https://www.stockatonia.co.uk/