Pension schemes will need to navigate around a number of headwinds in 2016 as investors adjust to a divergence in monetary policy, slowing global growth and steep equity market valuations, Kames Capital has said.
Patrick Schotanus, an investment strategist at the group, has identified a number of potential risks which could impact returns next year as markets recalibrate to cope with the Federal Reserve’s decision to raise interest rates this month.
As well as this major change in direction, other challenges also remain, with the risk of a Brexit, and continued volatility across fixed income assets if rates – and inflation – rise faster than expected.
Below Schotanus identifies four investment headwinds which schemes need to be aware of as they seek to maximise returns next year.
Schotanus expects the debate about Britain’s membership of the EU to come to a head in 2016, amid a shift among the electorate towards an exit vote in the wake of the migrant crisis this year.
Combined with the UK’s twin deficit – the current account and budget deficits now account for more than 10% of GDP – Schotanus said sterling could weaken sharply against other currencies.
“We think sterling will face a headwind in 2016 given we face an increasingly likely referendum on Brexit, and with the UK’s double deficit also impacting sentiment,” he said.
“A rate hike is also unlikely until much later in the year, so sterling’s recent spell of weakness could well continue.”
US housing market
US housebuilders have benefited from the return of house price growth in the US following one of the sharpest downturns on record.
However, having outpaced the wider stock market over the last few years, they started to correct in late 2015. One way to assess how much further this trend has to run is to look at housebuilders versus lumber, one of the core raw materials needed in house construction.
“If you do a ratio of housebuilders to lumber, the stocks have come back some way from the peak seen earlier in the year,” he said.
“Housebuilders got too expensive, and now as the Federal Reserve starts to hike rates, it will put renewed strains on the sector. Therefore, housebuilders should see share prices mean revert back to their historical trend versus lumber, and so going underweight (or indeed short) the sector looks attractive.”
Airlines such as easyJet have benefitted from the capitulation in oil prices over the last two years which provided a direct boost to their revenues.
However, with share prices vastly outpacing moves made by equity markets in general (easyJet, for example, is up 262% in five years, versus a gain of 4.14% for the FTSE 100*) and oil prices unlikely to fall by anything like the amounts already seen over the past two years, Schotanus said valuations looked stretched.
“Airlines globally have benefited from the collapse in energy prices, but that is done now, and it is definitely an industry to be underweight, or even short,” he said.
The ultimate store of value has endured a torrid 2015, falling almost 20% from its peak of $1,300 earlier this year to just $1,056 per troy ounce currently**.
Schotanus said the strength of the US dollar had been one of the main causes of the precious metal’s decline, and while it may stabilise in 2016, he warned schemes it was unlikely to recover next year.
“It is quite possible we have seen the biggest part of the upward move for the US dollar, so that may help gold, but in reality the best we can hope for is that the price stabilises around the $1,000 mark,” Schotanus said.
“We would need an extreme event in order to provide a real boost to gold, and given the current economic outlook globally is fairly benign, it is hard to make a case to invest at these levels when there is likely to be further pressure on the asset.”
*According to Google Finance, as at close of the markets on 17/12/15.
**According to FT data, COMEX GOLD 1 FUTURES CHAIN Front Mon peaked at $1,303 on 21 January. It closed on 17 December at $1,055.5.