The CIO of the private banking arm of Lloyds Banking Group sets out his predictions - and some asset allocation calls - for the year ahead.

This publication recently met with Markus Stadlmann, who is chief investment officer at the private banking arm of UK-listed Lloyds Banking Group. He has previously held management positions at Erste Group in Vienna and Barclays in London. At Barclays, Stadlmann led the portfolio management and specialist investment teams which looked after the wealth management needs of 28,000 affluent and high net worth customers.

Prior to joining Barclays, Stadlmann was managing director of Harald Quandt Holding and CIO of HQ Trust, one of the largest family offices in Europe. He also spent eight years at Siemens AG, initially as fund manager. He eventually became CIO of the pension fund and a member of the leadership team of Siemens Financial Services. Stadlmann received an MBA from the University of Chicago Graduate School of Business (later re-named Chicago Booth). 

How many people work with you in your team?
WIO team is currently 122 people strong.

What is your current attitude around the US economy and your bank’s asset allocation weighting on the US? Are there specific risks/opportunities you see in the US for the coming year?
The US economy grew a modest 1.5 per cent annualised in the third quarter as solid domestic spending was partly offset by inventory drawdown and external headwinds. The latter are set to remain a drag in coming quarters, but healthy domestic conditions should support GDP growth in 2016. Labour market slack continues to dissipate, with 271,000 jobs added in October and the unemployment rate falling to 5 per cent.

Wage growth is also finally picking up, with hourly earnings growing at 2.5 per cent on the year. Inflation is depressed by low energy prices and the pass-through from the stronger dollar. We expect a continued decline in commodity prices and rising spare capacity in US manufacturing. This should mean that inflation will not rise much next year. I see headline and core PCE inflation at between 1-1.5 per cent, respectively, by mid-2016. Following the rate rise in December, we expect the subsequent tightening cycle to be unusually slow, and see fewer hikes in 2016 than the Fed has indicated. 

We are currently underweight in US equities. Valuations are high, cost of capital for companies is rising and being overweight is generally accepted to be the right position for multi-asset investors. This means that the US equity market is vulnerable to a significant correction.

Regarding the eurozone, there is considerable variation in performance. Firstly, do you have a general view of the eurozone from an asset allocation point of view and, second, are there specific countries you like, are bearish on, and why?
The German economy is rebalancing away from exports to domestic consumption and higher wage growth would be hugely important. The German and French economies are diverging as we see France has issues, maybe not the same demographic problems but the budget and economic policies are not working. The recent election bought some relief as the feared growth of the far right didn’t quite materialise. 

Italy is one to watch. When he came to power in February 2014, Matteo Renzi promised to implement sweeping reforms within a single month - not surprisingly, he wasn’t immediately successful. He has definitely made some noticeable progress since then. The country is emerging from a three-year recession thanks to a combination of low oil prices, the European Central Bank quantitative easing programme and a weakened euro. An OECD report earlier this year confirmed the range of reforms currently being pushed through by the Italian government resulting in positive structural change. The effect of already implemented reforms on Italy’s GDP over a five-year period will be a boost to real gross domestic product by between 0.7 per cent and 1.4 per cent. Further progress is expected.

The recent flotation of the 153 year old national post office is hugely symbolic and represents the biggest privatisation push since the late 1990s, when Italy sold stakes in energy groups Eni and Enel. The move illustrates Renzi’s ambition to sell off state assets and was intended to raise about €4 billion from listing a 40 per cent stake on the Milan stock exchange in late October. He is trying to make Italy a more efficient and effective machine, and his early efforts to break down some of the barriers that have hindered the economy for so many years, appear to be gaining momentum.  

In conclusion, the signs of progress being made in Italy are encouraging. It might not be at the speed that was first promised by Renzi, but it is at least moving in the right direction. We think that the risk and liquidity backdrop for Italian equities remain favourable, while Italian bonds are fairly priced. However, productivity remains a major hurdle to overcome if the government is to achieve long-term economic growth.

Similarly, what is your stance on the UK economy from an investment point of view?
I am positive about the UK as we see an uptick in real wage growth early next year, but we’re not sure yet if this is short-term or the beginning of a multi-year trend. For 2016 this would support consumption growth which in turn is a major contributor for GDP growth – it constitutes 70 per cent of the economy. With employment looking stronger there could be even better times ahead. This is of course provided that external events – such as a hard landing of the Chinese economy – and policy challenges – such as an adverse outcome of Britain’s EU referendum – will not shock investors.

Please also give your emerging markets stance; are there specific likes and dislikes in this category? Are there any contrarian bets and views you have about the EM market?
Brazil is to be avoided until 2018 – too many reasons to remain cautious. But I’d like to highlight Mexico – for some reason it’s not covered enough! Mexico is a market where we see good fundamentals in place, but also a number of challenges. In his last state of the nation address, President Enrique Peña Nieto admitted that 2015 had been a “difficult” year.

Although growth has stuttered, wages and consumption rates are rising, while inflation remains under control. For a number of years, Mexico has had political stability although the government is facing growing pressure to address issues such as rising levels of inequality between social classes. Close commercial ties to the US means that when the US economy improves, Mexico’s economy feels the benefit. Mexico also has Latin America’s largest and most sophisticated industrial base, exporting more cars than any country except Germany, Japan and South Korea. 

There are solid labour market dynamics, with rising employment levels but at the same time, wages are rising only moderately and therefore, there are no wage-induced inflationary pressures. Whilst economic growth might be sluggish, it is not stopping Mexicans from spending. Cars sales are up 25 per cent from September 2015 – September 2014, whilst Walmart, Mexico’s biggest retailer, announced a 7 per cent rise in annual same- store-sales in September.

One noticeable reform effort in 2015 that has stuttered, however, involves the energy sector. The government wanted to attract private investment to help boost the exploration and production of oil. But with oil prices plummeting this year, investor appetite has dropped off.

In conclusion, Mexico has had two decades of solid macroeconomic management and although the middle class population is growing and consumption is rising, there are key areas where further reform is needed. 2016 could be a key year for the president. Mexican equities are also attractive from a corporate perspective. Profitability is expected to reach a new high in 2016. 

What has been the largest surprise from your point of view in markets over the past year, and why? What do you think has gone as predicted?
In a rather unsurprising year, I would say the two things that I found interesting was firstly the way there was such surprise at the way China slowed down in the summer. On our activity measures, the Chinese economy has been growing at a much lower level than public statistics would lead you to believe. Secondly, the seeming lack of clarity on monetary policy from Mark Carney who is normally easier to read - although I think it is a good call to hold rates.

In setting investment strategy, you talked a bit about some of the five virtues of investing. What would you say is the supreme virtue that an investor should cultivate, and why?
I would choose the ability to identify imminent trend reversals as the prevailing virtue to focus on. Today, returns have memory, consequently trends are more common these days than they used to be. Identifying them early - even if you are not leading the pack - is a key success factor. We made a good call with excluding commodities from our investment policy at the end of 2014. Today, most of the bear market in commodity prices is behind us - at a much quicker pace than we thought it would unfold. But I wouldn’t remove a strategic underweight in commodities, commodity currencies, and equity markets with a significant exposure to materials and energy companies just yet. Prices have further to fall.

There has been a great deal of debate in recent months about what is happening in China and its economy, amid concerns about the reliability of data and the like. Are you still taking a cautious view and investing via proxies or other markets, such as Hong Kong?
At the beginning of 2015, investors feared a significant slowdown with some serious knock-on effects beyond China. Although we have definitely seen a slowdown, 2015 hasn’t experienced the “hard landing” that investors were bracing themselves for. Manufacturing is struggling, with a decline in orders, although it is nowhere near as severe as the fall we saw towards the end of 2008. However, government spending is rising with authorities ramping up fiscal stimulus. For example, government spending had increased by 26 per cent in August 2015 compared to one year earlier. There are many things that give China a competitive advantage and should help its economy to grow in 2016. These include scale, infrastructure and a growing middle class population. Although its foreign exchange reserves have dropped very slightly since the beginning of 2015, they are still so high as to be unrivalled.

Beijing’s major recent reform efforts have focused on increasing centralised government power, improving the quality of governance, and the growth of the economy. We can’t know for certain but expect that current stimulus efforts should give Chinese equities, and emerging market equities, a boost in 2016.  

Can you set out what you think about the India story, given that this had been a bright spot in 2015?
The question for investors is quite simple: have all impediments been cleared for India, allowing it to embark finally on a sustainable growth path? India is another country whose reform efforts – in this case driven by Prime Minister Modi – have generated a lot of publicity.

The scale of the reform programme is ambitious for the country, which is expanding at a rapid rate. So much so that the UN has brought forward to 2022 its prediction that India will surpass China as the world’s most populous country. Since Prime Minister Modi came to power, a significant number of bills have been passed into law by Parliament, but he has also encountered some challenges that have threatened to derail his reform efforts. The benefits of economic reform to date include reducing corruption, liberalising foreign direct investment and advancing with infrastructure projects. And lower oil prices have given the Reserve Bank of India greater freedom to cut interest rates. 

Additionally, foreign reserves are at record levels, and the country’s currency - the rupee - is performing well against the world’s 10 most traded currencies and emerging market currencies. What’s more - the resilient equity market has been testament to India’s progress. If the majority of the structural reform agenda is eventually implemented you could see a multi-year upswing. 

Time will tell if the recent troubles for Prime Minister Modi are symbolic of bigger problems ahead but for now we still believe the reforms are well timed, necessary and driven by a genuine ambition to achieve real, long-lasting change for India.