The experts at Bank Julius Baer are convinced that in the current global economy cyclical divergence has become more pronounced – both among developed and emerging markets, where a majority of strengthening economies are increasing their growth momentum, while those that are already weakened continue to struggle. This divergent backdrop is set to last in 2015, though the contrasts between countries should narrow as the year progresses. A key point for investors is that policy and exchange rates may continue to diverge next year. The investment mantra for 2015 is thus to stay the course, stay liquid and look for growth themes.

Among the developed and emerging markets, a majority of economies with underlying positive growth are showing signs of further firm momentum in the months ahead. In the wake of the US, which has become a leading global growth driver, major economies such as Canada, Mexico, the UK, Switzerland, Spain, the Netherlands and Sweden are on course to increase their cyclical momentum in the months ahead. In addition to these economies, a strong group of countries in Asia, with China and India in the lead – in purchasing power terms the numbers two and three in the world in terms of size and both with strong governments in place – will continue on steady growth paths and contribute considerably to a global growth figure of 3.6% in 2015. This overall growth rate is only slightly higher than the 3.2% for the current year, because an important group of economies will continue to underperform growth-wise next year. As an entity, the eurozone will remain the major laggard among the group of developed countries, with an average growth of 0.8% in 2015. In terms of divergence, it, too, will be a mixed bag. Alongside the more dynamic Spain and Netherlands mentioned above, the eurozone’s three major economies are doing less well, with Germany experiencing cyclical sluggishness, France stagnation and Italy recession. Sluggish eurozone demand will have a negative impact on Switzerland’s growth, more than offsetting the tailwind from a stronger US dollar which is now benefiting Swiss exporters to the Americas and Asia. In the emerging markets, on the other hand, the cyclical bottoming out now under way seems to be taking longer than expected, so that major economies such as Brazil, Russia and South Africa will continue to show sluggish or even recessive growth momentum for the time being.  

Large global output gap to last

Janwillem Acket, Julius Baer’s Chief Economist, explains: “It comes as no surprise that, globally, the average supply momentum will remain lavish relative to demand, thus constraining companies' pricing power throughout 2015. Major central banks will therefore have more time to ‘wait and see’.” Modest positive growth momentum and weak inflation suggest that the beginning of monetary policy rate normalisation could be delayed to Q4 2015 or even later, depending on economic data. Among the G10 central banks, the Federal Reserve and the Bank of England are now widely expected to be the early movers in this transition next year. Monetary policy, however, is another area where the major economies are beginning to diverge, as looser monetary conditions will remain a priority for longer at the European Central Bank (ECB) and the Bank of Japan. Against this backdrop, the Swiss National Bank must maintain its current policy of doing all in its power to defend its 1.20 EUR/CHF currency floor, implying that it will need to maintain its policy of shadowing the ECB by targeting near-zero rates. Based on fundamentals, and for a 12-month time horizon, the Canadian and New Zealand dollars, the Hungarian forint, the Mexican peso, the Chinese renminbi, the South African rand or even the Indian rupee offer more potential for appreciation than the currencies of the above-mentioned G10 central banks.

ECB in a conundrum – caught in the role of monetary policy driver and bank supervisor

The ECB faces the dual obligations of setting monetary policy and supervising the eurozone’s banking system. As a monetary policy driver operating at near-zero rates, it is attempting to spur eurozone growth and fight deflation. On the one hand, the ECB is talking down the euro exchange rate, to bolster the price competitiveness of eurozone exporters. On the other hand, it is using unconventional measures, like targeted credit facilities and asset purchases, with a view to enlarging its balance sheet by EUR 1trn, as a means of bringing an end to the ongoing credit crunch in the eurozone periphery and generally promoting bank lending. However, as a supervisor of the system-relevant eurozone banks, the ECB has to ensure the unhealthy bank balance sheets are deleveraged and their stability strengthened. Due to stricter regulation, eurozone banks have amplified their capital and reserves to an extent that ensures they have ample access to central-bank liquidity. Nevertheless, as the eurozone economic environment remains fairly risky for aggressive credit engagement, the banks concerned are proving restrained in their appetite for further ECB liquidity. In these circumstances, the ECB will neither be able to achieve the goal of widening its balance sheet by EUR 1trn nor to weaken the euro more permanently, since it is already fundamentally undervalued. “Once the looser monetary conditions the ECB has had in place since mid-2014 start to foster eurozone growth from Q2 2015, upward pressure on the euro will increase during the course of the year,” Janwillem Acket concludes. A forceful currency management with an ‘SNB style’ currency ceiling would seem a very sensible idea at this juncture. In the short term, however, such an ‘all in’ measure is unlikely. The big unknown is how the ECB will tackle these imminent trends.

Investors should stay the course, stay liquid and look for growth themes

For investors, this means that policy and exchange rates may continue to diverge in 2015. Christian Gattiker, Julius Baer's Chief Strategist and Head of Research, thinks that this will hold true in particular with the Anglo-Saxon economies, where rate normalisation may become a major topic – in contrast to Europe or Japan. Divergence will also be apparent elsewhere in the world, with countries like China and India standing to benefit from reforms implemented in 2014, while laggards such as Brazil and South Africa drag their feet. Despite a challenging environment, equity markets should turn in a decent performance in the months ahead, with rates seeming well anchored in the short term, inflation tame, monetary policy likely to stay supportive overall and corporate profitability high or improving. In contrast, global bond markets seem ever more overpriced, even though they are unlikely to spoil the mood any time soon, since there are enough central banks willing to buy any overhang. As Christian Gattiker sees it: “The mantra for investors in 2015 is to stay the course, stay liquid and look for growth themes.”

  • Stay the course: the investor’s dilemma (‘Anlagenotstand’) remains, as central banks are in reflation mode across the globe.
  • Stay liquid: investors should reduce illiquid assets unless they are ready to hold them over the whole cycle. As the rate normalisation theme may return to haunt markets every so often, illiquid assets may prove hard to sell.
  • Look for growth themes: with many assets on stretched valuation levels, the only prospect potentially providing relief for many companies is to grow their way out of their current demanding earnings multiples. Hence investors will not find great returns from passive investments. Instead, they will need to look for growth themes in areas such as electric cars, disruptive digital technologies, energy infrastructure and education.

For sound policies go to Asia – for growth to healthcare and expanding dividends

In recent months and quarters, the new governments established in China, India and Japan have put reforms in place that will benefit the economy and financial markets in 2015. China, in particular, is in the process of reforming its state-owned enterprises (SOEs) and this will spur a dynamic of its own both in real economic and financial-market terms. When it comes to Europe and the US, investors will be best off holding on to the shares of dividend growers, or ‘dividend aristocrats’, companies which have been expanding their payouts to investors consistently over the years. Also – after years of expensive valuations, lack of product pipeline and government reforms to the sector – healthcare is now in a new long-term upcycle. In regional terms the specialists at Julius Baer prefer the US over Europe. They also favour emerging Asia over anything else in the emerging markets. With regard to Europe, either a clear decision by the European Central Bank to use all the means at its disposal to unblock the growth and credit logjam or a clear healing of the European economy would trigger an outperformance by European assets. The likelihood of either of these things happening any time soon seems somewhat limited, however. This implies that investors should wait for a clear and substantial change of direction before redirecting funds towards Europe. Switzerland and Swiss assets should, conversely, continue to do well, particularly the shares of companies active outside Europe.