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TT’s surprises for 2015

WorldWatch
17 December 2014

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TT's Ideas Factory propose several potential investment surprises for the year ahead. 

As is customary at this time of year, many of our fund management competitors and most of the broking community write outlook pieces for the coming year.  Whilst these certainly have merit and are interesting to the reader, we are, as ever, keen to avoid following the herd.  Instead, TT's “Ideas Factory” – a combination of all our investment teams – has compiled our potential investment surprises for 2015.  These are a collection of standalone ideas that could have important ramifications for markets if they were to come to pass.  Readers should be clear that these most certainly are NOT our base case expectations. In some instances they are light-hearted speculation, and in others they are more serious possibilities worthy of greater consideration during portfolio construction. In all cases, we believe that they are not priced in, and have the ability to influence markets substantially in the year ahead.  We hope that you enjoy reading them.

US reaches escape velocity

Stronger than expected economic growth in the US drives rising wage pressure, causing the Fed to raise rates in the second quarter by 25 basis points – earlier than current expectations – and implement a further three rises by year-end.  This policy tightening stands in stark contrast to the rest of the world, where central banks remain highly accommodative. As a result, the dollar surges and 10 year yields rise above 3% (versus 2.05% at the time of writing).  After many years as the leading performer amongst developed world stock markets, the S&P struggles to rise over the year, weighed down by a combination of currency-related earnings downgrades, weak oil earnings, rising interest rates and corporate margins slipping from all-time highs. Stock market volatility (as measured by the Vix) rises.

Draghi hits his stride

European equities struggle in the early part of the year as German legal challenges curtail the implementation of Quantitative Easing (QE).  When it belatedly gets going, and with headline inflation dropping into negative territory, Draghi quickly accelerates QE, exceeding the €1 trillion currently expected. The euro falls towards parity with the dollar and the ECB ultimately takes on the sovereign credit risk of its member states – a major step towards fiscal union. A supportive central bank, coupled with a faster pick-up in economic growth due to the falling oil price and weak euro, mean European equities surge ahead and outperform other developed regions by year-end.  As confidence returns, the euro stages a strong recovery late in the year. 

Oil continues to tank

Saudi Arabia maintains current oil supply despite growing pressure from other producers. Brent stabilises below $50 for much of the year before evidence of capex reductions in Russia and the US eventually see it rise to $75 towards the end of 2015. Hefty earnings downgrades cause unexpected dividend cuts at many big oil producers, but the weak oil price causes a material boost to consumption within oil importing economies. This helps global growth to accelerate beyond expectations. 

Abe hits the bullseye

Following a resounding victory in Japan’s snap election, Abe’s third arrow hits the bullseye in 2015, with his reform programme making significant progress. Oil price weakness provides a strong tailwind to growth but dampens inflation, forcing the Bank of Japan to further increase the pace and magnitude of QE. The yen falls to 130/$. Japanese corporates embrace a major restructuring drive, increasing Return on Equity towards the global average and raising dividend payout ratios in the process.  This drives the Nikkei 225 to over 20,000. 

Petrobras goes under

Petrobras – responsible for over 90% of Brazil’s oil production – becomes the largest corporate bankruptcy in emerging market history, swamped by its $122bn of foreign currency debt. Its borrowing problems are compounded by the weakening Brazilian economy, collapsing oil price, and fraud investigations that spiral out of control. Substantial assets are sold off to foreign investors and the company’s debt is rescheduled. Dilma Rousseff is not prosecuted in the trials that follow, but her guilt by association is clear to the electorate. By year-end her position as president looks untenable, particularly following an increasingly strained relationship with high profile finance minister, Joaquim Levy.  

UK political mess

In the 1959 general election the two main UK political parties took 96% of the vote.  In 2015, with a low turnout and the electorate disillusioned with the traditional parties, the UK election is inconclusive. Neither the Conservatives nor the Labour party have sufficient votes to gain a majority, even in coalition with the Liberal Democrats.  After two weeks of horse trading and virtual paralysis in government, the Conservatives emerge as leaders of an unlikely coalition with the Liberal Democrats, Democratic Unionists and UKIP.  The coalition becomes increasingly Eurosceptical, with a referendum on EU membership fast-tracked to occur within a year – a UKIP pre-condition to providing its support. Sterling falls to $1.40 and €1.15.

Emerging markets: growing apart

Emerging markets (EMs) divide into two distinct camps – the “haves” and the “have nots” – leading to extreme variation in performance. Oil producers with vulnerable external financing, such as Brazil, Venezuela and Russia, lead the latter camp and struggle to manage deteriorating economies and weakening currencies.  Venezuela, where oil accounts for 96% of export revenues, asks for assistance from the IMF as its economy collapses.  Asia dominates the “haves” with China successfully coordinating a “soft landing”, allowing stocks to re-rate strongly. Many EM currencies devalue against the dollar, most notably the yuan, which falls 20%.

The rise of radical politics

Extreme right- and left-wing parties gain popularity across Europe. Greece is the most notable example, where the radical-left Syriza party leads a coalition government in 2015 and agrees more favourable terms with the Troika.  In Spain, a popular wave of anti-corruption and anti-incumbent feeling allows a coalition of the Socialist party together with the far-left Podemos party to win a general election. They agree to hold a referendum on Catalonian independence. In France, President Francois Hollande fails a vote of no confidence as the “frondeur” MPs make their frustration heard. A legislative election is brought forward to 2016 with Front National and the centre-right UMP, under a rejuvenated Nicolas Sarkozy, running neck and neck in the polls.

The Russian bear growls

The Russian economy deteriorates sharply, plunging into a deep recession amidst an increasingly onerous debt burden. Sanctions bite, as does the weak oil price, with interest rates rising further to defend a crumbling rouble and spiraling inflation. Putin’s high personal approval rating craters, sparking more aggression towards the West and a full-scale invasion of Ukraine in a desperate attempt to get public opinion back on side.  Meanwhile, exiled former oligarch Mikhail Khodorkovsky plots Putin’s downfall with growing support, both in Russia and amongst Western leaders. 

Low rates come home to roost

After many years of all-time lows in short and long dated interest rates, the start of tighter monetary policy in the US and UK has some unintended consequences. Central London house prices fall 20%, with Russian and Middle Eastern buyers no longer providing support. Investors discover that many loans to oil producing nations and higher cost corporate producers go bad.  This particularly affects several European banks with exposure to the Middle East and Russia, and some US regional banks with excessive exposure to shale. Finally, the dollar high-yield bond market, a major vehicle of finance for the shale revolution, suffers a crisis of confidence as many of the loans are dangerously “cov-lite”.    


Important Information:

Nothing in this document constitutes or should be treated as investment advice or an offer to buy or sell any security or other investment. TT is authorised and regulated in the United Kingdom by the Financial Conduct Authority (FCA).

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