Summary views from Pavilion’s Investment Outlook – Q2 2015
Economic Backdrop: Growth remains uneven across countries
The IMF forecasts global GDP growth of 3.5% and 3.8%, for 2015 and 2016, respectively—a very modest improvement over 2014. Longer term pressures from population aging in advanced economies and slowing productivity growth in emerging economies remain in place. Nearer term, uncertainties related to the strength of the U.S. dollar and low oil prices have exacerbated already uneven economic growth patterns across countries. Central bank watching has become a favorite pastime.
Equity Market Valuation
U.S. stock market valuations are trading near historic average levels based on trailing 12-month earnings, but trending toward expensive on forward earnings. While valuations are still within normal bands, the Insider Selling/Buying Ratio is near an all-time high—selling remains strong while buying has been flat since late 2012.
Within the emergingmarkets, growth stocks have been outperforming since early 2012. A slowdown in cyclical sectors brought on by low oil prices and uneven growth trends likely are contributing to the preference for growth stocks, which have the benefit of better earnings visibility. Correlations between value and growth stocks remain very high and in aggregate, the evidence is not compelling to warrant a position favoring either style.
Small cap stocks performed strongly during the first quarter, fueled by the strong dollar and an increase in risk taking. While still within a normal range, in the U.S. small cap stocks are moving toward expensive territory relative to large cap stocks. Within Canada, small cap stocks look fairly priced relative to large cap stocks.
U.S. Large Growth vs. Value Price/Earnings Ratios—Growth Stocks Slightly Cheaper Than Value Stocks
Source: Russell cap-weighted indices
Relative P/E—Small Cap Stocks Moving Toward Expensive Levels Relative to Large Cap
Interest rates & Spread Sectors
Projected fixed income returns remain low given the current yield environment. With the exception of the U.S., the U.K., and Canada global growth forecasts for most advanced economies are just about 1.5% and largely will be achieved as a result of monetary stimulus that has pushed rates into negative territory, especially once adjusting for inflation, across much of the world. A strong U.S. dollar, low oil prices, and concerns about ramifications for emerging market countries, have pushed out projections for an increase in U.S. interest rates, to late 2015 or possibly 2016. U.S. interest rates are now
among the highest in the world.
Of $22 Trillion in Developed World Government Bonds, Three-Quarters Have Yields Below Rate of Inflation
Source: J.P. Morgan Securities LLC, April 21, 2015
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
Source: Angelo Gordon. PWC.
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