If there’s one overarching idea for global investing in 2015, it’s that overarching strategies aren’t a good idea.
In 2014, global markets started breaking a multiyear pattern in which different asset classes and geographic markets mostly moved in unison. Correlations are set to break down further in 2015.
Accelerating this breakdown is fact that central banks are going their separate ways – the Federal Reserve is preparing for a rate increase, the European Central Bank for more monetary easing – while energy producers and consumers are experiencing starkly different effects from falling oil prices.
The upshot: Global investors must do their homework. across-the-board bets on risk-sensitive assets such as equities or junk bonds won’t do; they will need to be more selective. The fundamental circumstances for each country, company or commodity must be assessed and differentiated. Investment positions will need frequent adjusting. Simplicity is ceding ground to the realities of a complex world.
“In a year when economic fortunes and central bank policies will diverge, it will be important to be positioned in a way that recognizes the challenges and identifies where the potential opportunities lie,” says Rick Lacaille, chief investment officer for State Street Global Advisors, which has $2.4 trillion under management. State Street is hoping that 2015 will better suit its bottom-up value-investing model rather than the top-down macro approaches that were favored during the highly correlated market movements of recent years.
Correlations became especially strong after the 2008-2009 financial crisis. During “risk on” periods, when central-bank monetary stimulus measures boosted confidence in the global financial system’s recovery, investors poured into all manner of “risk sensitive” assets, raising prices for emerging-market currencies, high-yield bonds, industrial commodities and equities indiscriminately. Then, during “risk off” panics such as those of the eurozone crisis, those flows would abruptly reverse and head to safe-havens denominated in dollars or yen.
However, herd investing has roots that precede the crisis. Its habits could be hard to break.
As Financial Times columnist John Authers noted in his 2010 book, “The Fearful Rise of Markets,” blame for the “global bubbles” and “synchronized meltdowns” of recent years lies with both official policymakers and with the professional investment industry. Former Fed Chairman Alan Greenspan gave rise to the “Greenspan Put,” which after it morphed into the “Bernanke Put” during Ben Bernanke’s chairmanship continued to signify the expectation that the Fed would always minimize investors’ losses in falling markets by flooding them with monetary liquidity. Meanwhile, government bailouts led Wall Street investment banks to believe they were too big to fail. At the same time, monthly assessments of portfolio performances led competing professional money managers to stick closely to their benchmarks, which meant they invested as a group. The same industry devised classifications that put disparate assets and markets under broad umbrellas, each tailored-made for the herd: “junk bonds,” for one, and, most significantly, “emerging markets.” All of this meant that nuanced insights were less valuable.
Meanwhile, economists were describing a world that seemed to be converging into homogeneity. The idea that globalization, information technology and improved policies were driving developing nations to catch up to the advanced economies became an article of faith that in turn encouraged parallel investment strategies. Its baseline assumption – that America was slowing and emerging markets were the future — couldn’t anticipate the late-2014 scenario where the U.S. is again the world’s engine of growth while developing nations such as Russia confront crises....MORE