It’s always interesting, and sometimes sobering, to look back over the past year to see where markets took us as well as to compare that with where the various headline-grabbing experts told us we’d be.
Here’s a quick overview of the asset classes last year.
Bonds: a tale of two markets
Broadly speaking there are two types of bonds: sovereign bonds, which are those issued by a country, and corporate bonds, issued by companies. For either type of bond, returns are a function of the yield they pay plus any change in price, bearing in mind when the yield goes down the price goes up. Having both benefited from the chase for yield over the past few years, by the end of the year we started seeing divergence between the two classes.
After a 20 year bull market that’s taken yields on sovereign bonds to below two or three percent returns have been widely expected to moderate for ages – after all, how low can bond yields go, right? There are two things that make yields go up: fear of either inflation or default, so arguably it’s not so much how low can yields go as what’s going to make them go up? Inflation is still nowhere to be seen, but fears of default are creeping in to the corporate bond market and that affected its returns last year.
For sovereign bonds the main influence over the year was again the central banks. The U.S. Federal Reserve stopped its quantitative easing program and the European Central Bank and Bank of Japan ramped theirs up – see the chart below. 2015 will probably also be remembered as the time when some sovereign bonds traded with a negative yield – at the end of the year you paid the Swiss government 0.2% to lend them money for 10 years! The other very noticeable change was the Emerging Market central banks selling bonds aggressively, mostly to raise money to buy their own currencies to stop them falling too sharply.
Changes in Central Bank asset purchases
In the high yield corporate bonds space, which is that part of the market that caters to companies that are considered a higher risk lending proposition so they are forced to pay higher yields on their bonds, the falling commodity prices caught up with the many energy and commodity-related companies that had taken advantage of the historically low interest rates and issued debt. When the price of a bond issuer’s underlying commodity drops by as much as a half the market starts to worry the issuer is going to struggle to repay the debt. By the end of the year default rates were up very modestly but the premium a riskier company had to pay on its bond yield (called the spread) had risen sharply, especially for Emerging Market companies – see the chart below. The implications of this will be watched carefully over 2016.
Increase in levels of ‘distressed’ yields for U.S. high yield bonds
Source: Deutsche Bank, Reuters
U.S. 10 year bonds, the bellwether for global markets, barely moved, with the yield rising from about 2.17% to about 2.25% over the year, which was still a fair way from the 3.24% consensus among U.S. economists at the start of the year. The Australian 10 year bond yield behaved similarly, rising from 2.73% to 2.81%. Not especially exciting.
2015 returns from selected bond indices (in local currency)
* Vanguard Index ETF
Source: Vanguard, IRESS, iShares
Equities: strong start, weak middle, flat finish
The Australian share market burst out of the blocks in 2015, inspired by interest rate cuts. By May the All Ordinaries was knocking on the door of 6,000 points, only to have it fall away over the next five months to finish all but flat for the year – see the chart below.
The Australian All Ordinaries over 2015
Source: Yahoo Finance
Once again investment banking strategists and tip-sheet pundits were bullish on shares, and once again none of them came close to forecasting what actually happened. The average of ten different strategists’ forecasts for the Australian ASX200 was a rise of 9% to 5,875 (with a high guess of 6,130 and a low of 5,460), whereas it actually went down by 2% to close at 5,295. While in the U.S. the average of 15 forecasts was for a rise of 8%, compared to a final result of -1%.
These results are no different to the long-term average. In the past 15 years the consensus amongst U.S. analysts has called for an average yearly increase in the S&P 500 of about 9.5 percent, whereas the actual average annual change was less than 4 percent. It serves to illustrate just how difficult it is to make short-term (12 month) forecasts on something with as many variables as share markets, and how risky it is to base your investment strategy on them.
With the tailwind of QE no longer behind it and the (very light) headwind of rising interest rates the U.S. equities market struggled to deliver positive returns last year, whereas the Euro Zone markets benefited from the ECB’s largesse and delivered healthy returns. A major concern was the effect of a rising U.S.$ on the Emerging Markets together with what effects the moderation of China’s appetite for commodities will have.
2015 returns from selected equities markets (local currency, before dividends)
Source: IRESS, MSCI
Commodities: what goes up…
Last year we described commodities as “the most un-talked about bear market” – wow, how that’s changed! Having ridden the China-inspired commodities boom and watched it crumble over the past four years, Australian forecasters are now searching for any signs of a recovery. As we wrote recently it is possible the boom in prices attributable to China’s massive urbanization program was a one-off, never to be repeated (unless India can get its act together), yet we are left with the legacy of a massive increase in supply, which translates into potentially low prices for a long time.
For 2015 the IMF Commodities Index – see the chart below – lost close to a third of its value, and it’s down by more than half since its peak in 2011.
IMF Commodity Price Index
Within the commodities complex the one that has captured most attention is oil, which fell another 30% last year, and which has now dropped an astounding 66% from its high in September 2013 – see the chart below. Once again though, a Reuters survey of 33 economists and analysts forecast North Sea Brent crude would be $74.00 a barrel – oops.
Crude oil price
2015 returns from selected commodities
Currency wars remained a very real feature of international markets last year but back in mid-2014 when the world started to believe Federal Reserve Chairman Janet Yellen was serious about raising U.S. interest rates, the dollar became a one-way bet, rising by more than 20% since then. More than half of that rise in the U.S. Trade Weighted Index came in 2015 – see the chart below.
U.S. Trade Weighted Index
Source: St Louis Federal Reserve
Meanwhile, the European Central Bank and the Bank of Japan both announced extensions of their aggressive quantitative easing programs which served to weaken their currencies. Despite the media reporting exchange rates as if they are football scores, in most cases it’s actually better for a country to have a weak(ish) currency, because it enables their domestic producers to compete against imports more easily and makes their exports more competitive overseas.
Here in Australia, Reserve Bank Governor Glenn Stevens has repeatedly tried to talk the A$ down, so with a fall of 8.6% in our Trade Weighted Index last year, he’d be quite pleased.
Changes in relative currency strengths over 2015
Source: IRESS, Federal Reserve, Bloomberg
Fingers crossed for a great year in 2016.