The private investment house ends the year with a neutral stance on equities and remains unconvinced that medium- and long-dated government bonds offer much return for the risks entailed.

Jonathan Bell, chief investment officer of Stanhope Capital, the private investment office, gives his market and asset allocation views as a New Year looms.

As 2015 draws to a close the ECB has announced additional quantitative easing in the eurozone, the Japanese central bank has reiterated its QE programme and in China the policy for the renminbi has been altered to allow the potential for a further fall in the currency against the dollar. Against this easing trend US interest rates have been raised for the first time in nine years.

This divergence of policy with monetary tightening in the US and easing elsewhere is set to continue in 2016. We expect US rates to rise by a further 0.5 per cent to 0.75 per cent during the year. 
Despite this policy divergence we do not anticipate the US dollar will rise significantly given the extent to which the currency has already strengthened over the last 18 months. 

In the UK growth is expected to remain above 2 per cent and inflationary pressures weak and no action on monetary policy in either direction is anticipated ahead of the referendum to decide whether the UK remains in the EU. Sterling will therefore be buffeted by the likely ramifications of the poll more than by economic news and we anticipate it will weaken a little ahead of what is likely to be a close vote.  
The direction of oil prices is likely to remain a key focus of investors. The oil price is hovering around an important chart support level at around $35. If it falls through this level some fear it could fall to around $25. In the short term, the recent price fall, coupled with the fall in other commodity prices keeps inflation low and provides a boost to anyone who is a net buyer of commodities: This includes commodity importing countries such as Japan and India as well as Western consumers (particularly in the US).

The fall in commodity prices (including oil) has been a major driver of financial markets in 2015. Markets such as Brazil have been hit with the currency and the equity market down by more than 10 per cent and 30 per cent respectively. In the US the High Yield Credit market has fallen primarily owing to the relatively large exposure to energy companies and for the S&P 500, corporate earnings will be flat for the year as a collapse in energy earnings offsets small increases, on average, elsewhere. 

Most forecasters expect oil prices to reach a floor at some point in 2016. But, at what level and when? Most of the equity managers we use are still underweight oil and have benefitted as prices fell. This positioning is in line with the consensus view of all the managers we meet. If we expect oil prices to hit a floor and then recover we need to consider when we should top up our exposure. Now, or once the worst seems to be passed? We are currently considering investing in energy equities early in the New Year.

The next OPEC meeting in June will be more interesting than the last. By allowing the oil price to fall the Saudi's have succeeded in preventing around $200 billion of exploration and production spending. Once they are confident that others will control supply in a sustainable manner they may reduce production themselves (if they anticipate that the increase in revenue from prices rising will more than offset a small production cut). 

The reason for the fall in commodity prices was not just an issue of oversupply. Weaker demand or weaker demand growth have also contributed, particularly the slowdown in Chinese growth. Despite global GDP growth forecast at around 3% in 2016, demand for most commodities is unlikely to increase significantly.  Chinese growth is likely to continue slowing at a measured pace, with a gradual shift in the economy in favour of the service sector. As a result shifts in supply are likely to be the major determinants of price movements.

In 2015, the Japanese market has been the standout performer of the major markets. Eurozone markets have performed well in nominal terms but have lost out in dollar terms by the fall in the euro, whilst the
UK equity market has been held back by its relatively high exposure to commodity companies.

We have previously admitted that our underweight call on US equities was made at too low a level (or too early). We have raised our expectations for the market, but still view it as slightly overvalued and expect it to underperform other markets. The eurozone by comparison benefits from lower valuations, a weaker exchange rate, support from monetary easing and low expectations. We therefore remain overweight European equities as we enter 2016. 

Companies in Asia and Emerging Markets also generally look attractive based on historic valuation comparisons. In the commodity economies of Brazil and Russia this reflects significant turmoil caused by the fall in the price of key exports as well as political issues (internal for Brazil and external for Russia). Asian markets by contrast are more concerned by the increase in US rates, a potential Chinese slowdown or a devaluation of the renminbi. 

Overall we finish the year with a neutral allocation to equities. On the one hand, the current bull market in equities looks long in the tooth and valuations are above average in the US, at a time when earnings growth is weak. On the other hand, valuations in most markets look close to or even below long term average levels and economic growth reasonable. Also, the returns from equities, in terms of earnings yield or dividend yield, look attractive compared to cash and bonds. 

Within our equity exposure we have had a strong bias in favour of quality and growth. These two themes helped our performance in 2015. Value has underperformed growth since the financial crises and it is rare for it to underperform for this long. We have therefore been reviewing our overall exposure and have started to increase exposure to some value style managers. 

We also maintain our concern that medium and long dated government or investment grade conventional bonds offer risk and little return. In 1997 Gordon Brown promised the UK “no return to boom and bust”. He was wrong then and we would be wrong now to believe that the risk of an inflationary cycle is not worth considering. We do not consider it likely, but it is worth ensuring portfolios are not overly exposed if it does occur.