Summary views from Pavilion’s Investment Outlook – Q1 2015
Economic Backdrop: Uneven with increased uncertainties
Global growth forecasts continue to fall with the IMF’s 2014 and 2015 estimates currently at 3.3% and 3.5%, respectively. Uneven economic growth, now exacerbated by low oil prices and diverging monetary policies, remains a central theme.
Equity Market Valuation
U.S. and Canadian stock market valuations are trading near their historical average levels, while international developed and emerging market stock valuations are trading near the bottom of their valuation bands. U.S. and Canadian stocks appear fairly priced relative to their own history and on par with EAFE trading at about 15x–16x forward earnings.
Emerging markets are trading below their historical average price/earnings levels and, at about 11x forward earnings, look inexpensive relative to the developed markets. Although U.S. stocks look expensive relative to other markets, economic and corporate fundamentals, as well as price momentum are positives. A strong U.S. dollar may, however, prove to be a headwind for corporate competitiveness and earnings, particularly for large-cap, export-oriented companies.
Improving economic momentum, especially that of the U.S., and the resumption of capital inflows are positive for emerging markets and should offset at least partially, the impact of higher funding costs as U.S. interest rates move up. Given stronger economic growth, improving competitiveness from cheaper currencies, and attractive valuations, emerging market stocks should perform as well or better than developed market stocks so long as countries continue growth-based strategies. A headwind for non-U.S. stocks, however, is a stronger U.S. dollar, which attracts more foreign capital to the U.S. to the detriment of foreign stocks.
U.S. Large Growth vs. Value Price/Earnings Ratios—Growth Stocks Slightly Cheaper
Relative P/E—Large and Small Cap Stocks Look Fairly Priced
Interest rates & Spread Sectors
Projected fixed income returns remain low given the current yield environment. Cuts to the global growth forecast and the resurgent fear of deflation in Europe along with increased geopolitical tensions have pushed out projections for an increase in U.S. interest rates possibly to 2016. Europe is likely to remain divided as established economies’ interest rates are low while the other countries’ (Greece, Spain, etc.) rates are rising on threats to end austerity and spending oversight.
10-Year Treasury Yield Up Slightly—Still Near Historic Lows
In general, this is a good time to maintain diversification and avoid reaching for return. Asset prices are up sharply around the globe and fewer opportunities exist with above-average return targets. Among the few opportunities remaining from the 2008 financial crisis are non-core loans held by European banks. European banks have been slow to deleverage, but are now accelerating the process. Closed-end funds that invest in these loans should be able to provide double digit returns.
Low energy prices could present another investment opportunity if prices remain low. Record debt issuance during the past several years as capital expenditures expanded have pushed the energy sector to 16% of the high yield bond index. Projects funded with this debt may prove unprofitable at oil prices below $50 per barrel.
European Banks are Selling Assets
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