Developments that may affect your portfolio in 2016
After a rocky start to the year in the financial markets, investors have been offered some relief since mid-February. We look towards the rest of the year and highlight three things that we are keeping a close eye on.
Broad equity indices recouped much of their losses during the second half of last quarter, and the return on credit bonds again turned positive. However, even though the indices are now more or less back to where they were at the start of the year, the financial markets look slightly different from when we entered 2016.
Three things that may affect markets this year
1) Lower interest rates
At the end of 2015, the US central bank (the Fed) hiked rates for the first time in almost a decade. Further, the Fed communicated that the continued liftoff path would be gradual, leading the market to expect four more rate hikes during 2016. However, as equity markets plunged at the beginning of the year, interest rates also fell, resulting in positive returns for high grade bonds. As such, high grade bonds provided investors with some protection, balancing a portfolio consisting of a mixture of equity and bonds.
When equities started their take off again in mid-February, yields rose slightly, but did not return to the level from the beginning of the year. High grade bonds are therefore now relatively less attractive, but still an important component of a balanced portfolio due to the attributes they offer.
Since mid-August 2015 we have gone through a period of higher volatility. This has come down significantly during the last couple of weeks. But the mere fact that the volatility, as measured by the VIX index is lower now does not imply that general uncertainty is lower. What we have experienced is that a large part of the volatility in the last couple of months is due to significant policy decisions, and such decisions are typically difficult to predict. As such, we should not be surprised if the volatility quickly rises. Further, new regulation geared to increase financial stability would also have an effect on market volatility.
Volatility itself is not necessarily negative, and could even be positive if used in a smart manner. With an objective and rules-based rebalancing scheme, investors can actually harvest a rebalancing premium, raising the expected return from their investments.
3) Large regional differences
Emerging markets have been out of favour for some time now, but this changed during the first quarter of 2016. Emerging markets outperformed developed market by 6 percentage points during the quarter, the largest difference in favour of emerging markets since 2009. Some of this could be explained by lower interest rates and a weaker USD, but also important is the extremely low starting point in terms of expectations for emerging markets entering 2016.
We do expect there to be large regional differences also going forward, and as such investors should make sure that their portfolio is well diversified across countries and regions, as well as between asset classes.
SKAGEN seeks to the best of its ability to ensure that all information given in this publication is correct, however, makes reservations regarding possible errors and omissions. Statements in the report reflect the portfolio strategist's viewpoint at a given time, and this viewpoint may be changed without notice. The publication does not constitute a recommendation, an offer, an invitation to purchase / sell investment instruments or to effect transactions.
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