Earlier, I discussed how this year’s performance versus 2015’s shows an interesting contrast across asset classes, regions, sectors, and styles. In many cases, those areas that performed poorly in 2015 have performed well in 2016, and vice versa. In our view, these significant changes in performance drivers can be explained by three broad themes that have prevailed thus far this year: a decline in bond yields, abatement in the strength of the U.S. dollar, and an increase in political uncertainty.
Theme 1: The Decline in Bond Yields—a Global Phenomenon
In our view, the rally in the bond market is thus far the defining characteristic of 2016. U.S., Japanese, and German 10-year government bonds are now at or nearing negative yields. The difference between equity dividend yields and bond yields has widened, and is particularly significant in Europe, where the equity dividend yield stands close to 3.5%, while corporate bond yields have plummeted to approximately 2.5%. The chart below illustrates.
Theme 2: U.S. Dollar Strength Abating, Fueling Commodities and Emerging Markets
The weaker U.S. dollar is one of the driving forces of the reversal we have experienced this year. After strengthening for a number of years, the dollar’s trajectory changed in 2016. We believe this is consistent with the fact that historically, the beginning of the U.S. tightening cycle has often coincided with a peak in the dollar. The slightly weaker currency has fueled a commodity rally, and by extension has helped emerging markets broadly. This represents a major shift from the trends we saw in 2014 and 2015, and it has been an important driver of the market performance thus far in 2016.
Theme 3: Political Uncertainty Increasing
While bond yields and the U.S. dollar have shaped the market environment, political uncertainty has also been important. Brexit may be perceived as an isolated U.K. event, but in a broader context, we believe Brexit can be ascribed to the post-global-financial-crisis disorder. There are five key elements characterizing this environment: elevated leverage; a growing discussion of wealth inequality; a focus on increasing immigration in Europe and the United States; a lack of productivity growth, which has been a focus particularly of academics and policymakers; and the implications of technological advances.
There are also broader, almost existential, questions about the nature of the state and the individual within that state. Despite increased cautiousness amid heightened political uncertainty, however, it is important to bear in mind that this does not necessarily, at least immediately, translate into poor equity-market returns.
What to Watch in 2016
Looking ahead, some themes are clear.
Corporate earnings have come back into focus. We’ve seen positive trends for high-quality growth companies, and have been adding emerging markets in our portfolios amid better fundamentals, broadly speaking.
Equity valuations are generally high globally, but emerging markets are a better value, in our view. This further supports our favorable stance and our continued weighting increase in broad portfolios, gradually closing the significant underweight we had a year ago.
We are beginning to see dominant technology platforms around the world. This is occurring not just on the software side, but on the hardware side as well, and that has continued to drive investment performance. Technology remains a key overweight for us from a global sector perspective.
Central bank influence remains important. While there is some discussion about the role of the central banks and whether their influence is poised to change, we believe they still have a key role to play and will continue to be a point of focus for investors, given the large debt levels and the changing role of the state going forward.
Disruption themes remain relevant. Lastly, while we believe that disruption is still a relevant theme, the nature of the disruption also remains very important. And, it extends beyond the technology sector.