We are maintaining a neutral view on U.S. equities but feel that it belies the level of activity beneath the surface. The S&P 500 Index ended 2015 almost exactly where it started and, as of mid-March, it was again close to that level. Since mid-February, risk aversion has lifted, and investors have returned their focus to underlying fundamentals. The fourth quarter earnings season marked the first time we’ve experienced three consecutive quarters of year-on-year declines since 2009, due to soft spots in the energy sector. On the economic front, U.S. manufacturing PMI data has steadied, construction spending has perked up, and the latest inflation and unemployment indicators appear favorable.
While taking high-conviction directional positions in asset classes such as U.S. equities has become challenging for asset allocators, we see widespread opportunities for underlying investment category managers who have the potential to add value through shorter-term trading or relative-value positions.
U.S. Equities: P/E Driving Equity Movement
Master Limited Partnerships
After much debate, the Committee moderated its view on MLPs over a 12-month time horizon. In spite of the downgrade, the Committee’s outlook is consistent with our longer-term expectation for MLPs and thus does not reflect a negative outlook for the investment category.
Due to a continuation of significant volatility and a persistently high correlation between oil prices and MLPs, the Committee chose to change its view at this time for the following reasons: After the rebound from lows in mid-February, our outlook for energy prices is that they stabilize in the near-term; we do not expect a significant additional rally from these levels as OPEC has failed to reach any binding production cuts and Iran has stated its intentions to increase oil exports. Given the magnitude of the decline in energy prices, even with the recent recovery, some MLPs and other energy-related companies will likely experience credit challenges in the coming months; while much of this is priced into markets, we believe that there will be additional negative headlines for investors to process. Risks remain in the global economy which could put additional pressure on MLPs and commodity prices in the near term, including slow growth in the developed world, additional turmoil in emerging markets, and heightened geopolitical risks. As a result, while valuations and yields in the MLP sector remain attractive, the short-term market environment may present challenges, leading to a neutral outlook at this point.
Developed Market Non-U.S. Equities
We are maintaining our slightly overweight view for developed market non-U.S. equities overall.
Europe:While some have questioned the efficacy of the ECB’s policies and easing measures, there is evidence that the domestic expansion continues at a modest pace. The good news: The eurozone is not cratering; however, the expansion is not accelerating and, due to a lack of investment and geopolitical crises, there is an absence of forces that could drive a more robust expansion.
Against this backdrop, the ECB eased forcefully in March, cutting the deposit rate further into negative territory and the main refinancing rate to zero. The central bank introduced four new targeted longer-term refinancing operations with four-year maturities and expanded the monthly QE purchase, which will now include investment-grade non-financial corporate bonds, by €20 billion per month. With these moves, the ECB demonstrated that it continues to have resources at its disposal, which should lend support to European equities overall.
Japan: We are maintaining our neutral view of Japanese equities. Like the ECB, the Bank of Japan (BoJ) is under increasing strain and investors are questioning the efficacy of its instruments. We’ve seen a crisis of confidence in Japan since the BoJ’s move to negative rates in late January, evident in significant yen strength and falling Japanese equity prices, with bank stocks particularly hard hit.
We believe additional quantitative easing is likely, including an expansion of JGB and equity purchases, which could help the BoJ regain credibility and authority. If further easing measures don’t materialize—or are rejected by the market—it could create a dangerous scenario in which BoJ governor Haruhiko Kuroda lacks the authority to act forcefully as the BoJ has in the past.
Developed Market Non-U.S. Equities: Europe Offers Favorable Equity Risk Premium
Source: Bloomberg, Neuberger Berman. As of February 29, 2016. Note: Equity risk premium is defined as the difference between Forward Earnings Yield (inverse of Forward P/E) of the region’s benchmark equity index and region’s 10-year nominal yield.
Emerging Markets Equities
We continue to hold a neutral view of emerging markets equities overall. Attractive valuations can be found, but we believe that China and Brazil remain key risks. Committee members discussed the importance of being tactical with allocations within emerging markets, but strategic in allocating toemerging markets. Active management can help identify opportunities and challenges within a divergent landscape.
Brazil: We continue to see near-term headwinds related to solvency and fiscal deficits; however, long-term opportunities could present themselves should Brazil experience meaningful political change.
Russia: Financial stability remains a concern, particularly with uncertain oil and commodity price outlooks.
India: The country remains a relative bright spot within the emerging markets complex and is well positioned with regard to external financing needs. India is faring well in terms of productivity gains and could continue to present infrastructure development opportunities.
China: Our neutral view on Chinese equities is predicated on a scenario in which the country, although under stress, muddles through in the near term. It appears to be increasingly likely, however, that China’s struggles will increase given the current policy mix, and that the country will be pushed toward a more significant clampdown on capital account/controls or a step-devaluation of the renminbi. We also see risks related to the Fed’s adopting a stance that is too hawkish, which could boost dollar strength and, in turn, induce further China stress. Going forward, we anticipate that China will need to use monetary policy more vigorously to support its fiscal policy.
Emerging Markets Equities: Brazil Facing Considerable Risk
Sources: FactSet. Data as of February 29, 2016.
About the Asset Allocation Committee
Neuberger Berman’s Asset Allocation Committee meets every quarter to poll its members on their outlook for the next 12 months on each of the asset classes noted. The panel covers the gamut of investments and markets, bringing together diverse industry knowledge, with an average of 24 years of experience.
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