After a Tumultuous Year for Investors, the Experts Look Ahead
The last year was a treacherous one for investors, including some top hedge fund and asset managers. Much of what happened in global markets can be traced to falling oil and commodity prices, which rippled through the economies and markets of most major oil-producing nations.
But low gas prices and a strong dollar were good for United States consumers, who had more money to spend, lifting the American economy. Even though broad market averages were flat, United States stocks reached lofty valuations by historical measures.
So will oil prices again drive markets in 2016, and in what direction? Will returns in international markets finally start to overtake those in the United States? Will the Federal Reserve’s campaign to raise short-term interest rates over the next year push up longer-term rates and hurt returns for fixed-income investors?
These are some of the big questions preoccupying investors as the new year gets underway. For answers, I turned to some of 2015’s most successful investors and analysts for my annual look at the year ahead.
So much went wrong for investors in energy and other commodities this year that it’s hard to imagine that 2016 could be any worse. This week, a barrel of Brent crude approached $36, the lowest since 2004, continuing what appears to be a record decline from over $100 a barrel in June 2014.
Supplies surged, as the United States supplanted Saudi Arabia and Russia as the world’s largest producer in 2015, thanks to the shale oil revolution. Iraq’s production came back on line and Iran’s production is expected to flood the market once sanctions are lifted. Producers were supposed to cut back as prices fell, thus increasing prices, but no one — especially the Organization of the Petroleum Exporting Countries — wanted to cede market share.
The strong dollar added downward pressure on oil and commodities, which are priced in dollars, as the Federal Reserve pursued a tighter monetary policy. Global demand for oil grew in 2015, but not nearly fast enough to keep pace with supply. And China’s economy, where rapid growth was supposed to drive demand for years, cooled noticeably.
With oil prices so low, it’s tempting to say the worst is over, as many hedge fund managers did earlier in 2015, only to get burned. But Damien Courvalin, senior strategist in the Global Investment Research Commodities team at Goldman Sachs, told me this week that it was too soon for the all-clear signal. While Goldman expects oil prices to recover eventually, even by late 2016, over the near term the same forces that drove prices to new lows in the last year, starting with oversupply, shadow the market. Goldman’s three-month forecast for oil prices is $38, about where they are now, but they could go as low as $20, Mr. Courvalin suggested.
“We’re more concerned about the downside risks than the upside potential at this point,” he said. “People keep asking if it’s time to get excited about energy, but we believe that conversation is premature.”
In theory, slumping prices, and the resulting financial stress for marginal producers, should lead to cutbacks in production. There have been some, “but supply has proven surprisingly resilient,” Mr. Courvalin said. After a long period of capital investment driven by high prices for oil and other commodities, many production facilities are only now coming on line, “and they’re going to produce, no matter what the price,” Mr. Courvalin said.
He compared recent oil price moves to the period from 1976 to 1989. After peaking in 1980, oil prices fell through much of the ‘80s, finally bottoming in 1988. So far, the current period, beginning in 2005, looks similar. If the pattern continues — a big if — a recovery should begin by 2018, which is still two years away. “It could even be another decade,” Mr. Courvalin said, “before prices sustainably return to the levels of the past few years.”
For insights into global stock markets, I turned to two of the year’s most successful fund managers, Kristian Heugh at Morgan Stanley and David Nadel at the Royce Funds. Each has the distinction of managing funds ranked No. 1 in their categories for 2015 by Morningstar.
Mr. Heugh, who is based in Hong Kong, manages the Morgan Stanley Institutional Fund Global Opportunity Portfolio, which gained over 20 percent in 2015. Mr. Nadel is senior portfolio manager in New York for Royce’s International Premier Investment Fund, which gained over 17 percent in 2015, and the Royce European Small-Cap Fund, up nearly 14 percent.
Both managers invest in relatively concentrated portfolios, by fund standards, that don’t closely track broad indexes, which helped them outperform their respective indexes in the last year by a large margin. And both avoided the energy sector. Mr. Heugh’s largest holdings as of November were Facebook, the software concern Epam Systems and Amazon. Mr. Nadel’s were VZ Holding, a Swiss financial services company; Clarkson P.L.C., a shipping firm based in London; and Bajaj Finance in India.
“They’re boring companies,” Mr. Nadel said, reflecting his investment philosophy, which focuses on companies that meet a modified version of the “five forces” that determine the long-run profitability of businesses, as developed by the Harvard Business School professor Michael Porter. “But boring can be beautiful.”
Many money managers are predicting another flat-to-down year for United States equities for the same reasons stocks were flat in 2015 — high valuations, expectations of rising interest rates, a strong dollar and continued weak oil and commodity prices.
But both Mr. Heugh and Mr. Nadel see opportunities going forward in international stocks. “The U.S. has outperformed the rest of the world for quite a few years now, and the strong dollar has been exacerbating this trend,” Mr. Heugh said. “These cycles tend to reverse themselves over time, sometimes violently.”
He sees many opportunities in Asia, including China, which he notes is still growing, even if at a slower pace. “Asia is trading at a discount to its historical multiples of free cash flow and earnings while the U.S. and Europe are trading at premiums,” he said.
But Mr. Heugh focuses more on fundamental stock analysis and less on broad geographic or macroeconomic forces. He said he looked for high-quality companies with competitive advantages that deter potential competitors. Then, “it doesn’t matter which region outperforms in a given year or three- or five-year period, you will become partners in great businesses and have the potential to benefit as partners over time.”
Mr. Nadel said he also looked for stocks of international companies that benefit from high barriers to entry. “I’m not big on predictions, but the stage is set nicely for investing internationally,” he said. While the Standard & Poor’s 500-stock index has risen 75 percent over the last five years, international small-cap indexes have contracted slightly. “Dividend yields are over twice as generous outside the U.S.,” he said. “I think in 2016 we could see some catch-up.”
He especially likes some companies based in India, a country with “some of the best 10-year prospects in the world,” and Brazil, whose market “has to have hit rock bottom — at least, I hope so.” He said he was “cautiously optimistic” about the prospects for emerging markets. He praised structural reforms in Japan and said a wave of immigration should eventually benefit developed European economies.
The long bull market in bonds sputtered in 2015, as the Fed finally raised its target federal funds rate by a quarter point for the first time since 2006. United States Treasuries and most investment-grade corporate bonds barely eked out positive returns, and junk bonds plunged in a panicky sell-off late in the year.
© Justin Lane/European Pressphoto Agency Traders at the New York Stock Exchange in December as Janet L. Yellen, the chairwoman of the Federal Reserve, explained the decision to raise the Fed’s benchmark interest rate.
Travis King, head of investment-grade credit at Voya Investment Management in New York, managed a 1.3 percent return for the Voya Investment Grade Credit Fund. While modest, that was better than most fixed-income funds, and Morningstar has ranked his fund the No. 1 corporate bond fund over the most recent three-year period. Mr. King said that even with the Fed expected to continue a slow but steady rise in interest rates, he anticipated modest positive returns again in 2016.
“Our market view is for a slow and gradual rise in the Fed funds rate, with Japanese and European rates staying very low,” Mr. King said. “In that environment, we think corporate bonds will be a winning trade, but you have to be selective.” In 2015, his fund rotated toward bonds from money center banks and other financial concerns, which helped it outperform its benchmark. He said he expected to continue that emphasis in 2016. “We think financials are still a good place to be overweight,” Mr. King said.
As for junk bonds, he said he thought that the worst of the sell-off might have run its course. “Yields are starting to push 9 percent,” he said. “People are still avoiding high-yield debt from the energy sector, but elsewhere you’re seeing some stability. In a world where the 10-year Treasury is yielding 2.25 percent, 8 percent or 9 percent starts to look pretty interesting.”