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Legg Mason: 2015 should provide opportunities in US and global markets

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Legg Mason: 2015 should provide opportunities in US and global markets

But the details will matter.

Looking back on 2014 as year-end approaches, and looking forward to 2015, the affiliates of global asset manager Legg Mason offer a diversity of forecasts for the prospects of the world’s financial markets. Some markets may rise, some fall, but the overall outlook suggests 2015 should be another good year.

As Western Asset’s team forecasts, “A stronger U.S. dollar, lower oil prices and muted wage growth should continue to put downward pressure on inflation. The prospect of muted inflation, with the risks tilted towards inflation moving even further below the Fed’s target, should continue to keep bond yields low, thereby supporting bond prices.”

“We are right at the cusp of a major change." 

While generally positive in their outlook, the Permal team draws a more cautionary conclusion about conventional credit strategies, noting that opportunities will be very specific: “We are right at the cusp of a major change. That’s not to say credit will become catastrophic, but it is likely to be much harder to generate real returns going forward.”

Additional insights from the affiliates include:

·      The U.S. economy should continue accelerating on the back of strong private-sector expansion, allowing growth to gradually replace liquidity as the economy’s paramount support.

·      U.S. corporations have a record $10 trillion in cash on their balance sheets. How they allocate that cash and other capital assets should impact earnings, stock prices and value creation.

·      At least one major economy, the U.S., is moving toward normality and has emerged as the driver of global growth. But we are also in an environment where geopolitical unease is rising.

·      The global economy should continue to expand, aided by accommodative central banks and improving private demand. Many central banks should continue to ease monetary policy, including the European Central Bank (ECB) and the Bank of Japan. This should provide an impetus to growth, while also supporting financial markets.

·      Growth in Continental Europe remains, at best, anemic. The benefit of a more open-handed ECB, the heavily promoted €300 billion infrastructure fund and the declining euro could add up to a solid year for select European companies.

·      Japan and Europe, both beset by structural headwinds, may require further currency depreciation, labor reform and positive external surprises before liquidity support can safely be removed. A cheaper euro will be an integral part of success.

·      Europe has its back against the wall, and will have to choose whether to be a hero or a zero. Should economic growth continue to be anemic and inflation expectations continue to fall, the Eurozone may have to choose between a deflationary spiral similar to what Japan went through in the 1990s or a more aggressive, full blown quantitative easing program, with direct purchases of government bonds.

·      China should manage a soft-landing.

·      Japanese companies are experiencing the best earnings and dividend growth in the developed world. This fundamental improvement has yet to be discounted in share prices, with valuations remaining among the lowest in the world. Low expectations for improvements in profitability and growth set the scene for continued upside surprises.

·      But, there are macro factors to consider. If Abenomics doesn’t work, the huge sucking sound coming from Japan could challenge economic growth in all of Asia. Japan’s central bank understands the stakes. By acting aggressively, the Bank of Japan demonstrated to both investors and policy makers its commitment to reigniting inflation in the Japanese economy. A declining yen would allow Japan to be a more competitive exporter, and should boost inflation as well.

·      Recent policy changes in certain emerging market (EM) economies, including Mexico, should lead to increased efficiency and output.

·      EM equity markets appear to be diverging: countries which need rapid Chinese growth to continue because they are driven by exports of natural resources to China, including Chile, Peru, and Brazil; and those far less dependent on China, namely Mexico, Korea, Indonesia, Malaysia and Philippines. These regions bifurcate with Mexico benefiting from the U.S. economy, while the likes of Brazil are in a far tougher spot.

The affiliates also offer strategic suggestions for investors across fixed income, equities and alternative markets:

·      Long-dated U.S. Treasury bonds should provide the best diversification for risk positions.

·      Broadening global growth should be favorable for many sectors, including corporates, mortgages, and emerging markets, which should benefit from the additional yield relative to Treasuries, as well as from improvements in the credit quality of underlying entities.

·      Local EM debt should provide the most attractive value. EM currencies and bond yields now offer elevated risk premia because investors are fearful of slowing global growth and a potential repeat of past crises.

·      Expect a continuation of M&A activity across most sectors of the economy. Low interest rates have enabled financing of acquisitions at attractive terms, and the threat of higher rates in the years ahead may speed up deal-making.

·      Healthy balance sheets and still-low payout ratios should also lead to solid dividend growth, extending the “Golden Age of Dividends.”

·      The recent small-cap correction has been rotational — it has been going on, quietly, for a long time. Examination of the index suggested that the rotation left many high-quality small-cap stocks still undervalued.

·      Divergence of economic conditions creates many interesting trading opportunities, in currencies, fixed income, country vs. country from an equity standpoint, or even a particular country’s equity market between winning and losing sectors.

·      Opportunities in credit are likely to be very specific. With higher U.S. interest rates come a higher number of defaults – and struggling companies will find it difficult to sustain themselves.

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