by The worst of the market turmoil is behind us, but the upside for equities looks limited After large market swings in the first quarter, our baseline scenario for 2016 remains intact: we continue to see an absence of momentum for financial markets due to a lack of earnings growth, limited upside due to already rich valuations, and recurring spikes in volatility. In this environment, an active tactical asset allocation is key, in order to boost returns by playing the ups and downs of the market. Robust diversification is also vital, in order to protect portfolios against shocks to equity markets. A bad quarter for active managers The first quarter of 2016 started with a double-digit decline, followed from 11 February by a double-digit rebound. This V-shape recovery was very hard for active managers. There was also almost total sector inversion: the sectors that performed worst in the sell-off (and which have been shunned by active managers for the past couple of years), such as financials and raw materials, were those that did best in the rebound. And the most defensive sectors, which had resisted best during the market downturn up to February 11, were the ones that fared worst in the subsequent rebound.
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The worst of the market turmoil is behind us, but the upside for equities looks limited
After large market swings in the first quarter, our baseline scenario for 2016 remains intact: we continue to see an absence of momentum for financial markets due to a lack of earnings growth, limited upside due to already rich valuations, and recurring spikes in volatility. In this environment, an active tactical asset allocation is key, in order to boost returns by playing the ups and downs of the market. Robust diversification is also vital, in order to protect portfolios against shocks to equity markets.
A bad quarter for active managers
The first quarter of 2016 started with a double-digit decline, followed from 11 February by a double-digit rebound. This V-shape recovery was very hard for active managers. There was also almost total sector inversion: the sectors that performed worst in the sell-off (and which have been shunned by active managers for the past couple of years), such as financials and raw materials, were those that did best in the rebound. And the most defensive sectors, which had resisted best during the market downturn up to February 11, were the ones that fared worst in the subsequent rebound. As a result, according to BofA Merrill Lynch, very few active managers beat indexes—only 19% of US large-cap managers and 6% of US growth managers outperformed the S&P500—the worst showing since 1998.
The period of maximum stress for markets now looks to be behind us, for the moment. Chinese growth is improving, commodity and energy prices have rebounded, the US dollar has weakened, and the package of measures unveiled by the European Central Bank (ECB) at its March 10 meeting surprised by its amplitude.
Nonetheless, we still believe it is worth favouring, nimble, more tactical, short-term plays over large-scale strategic bets.
Overall, earnings growth estimates for 2016 have fallen to just 1.6% for the S&P500 Composite and 0.8% for the Stoxx Europe 600. Despite the downward revisions, market valuations are close to their previous peak, with a price/earnings ratio of around 17x for the S&P500 and 15x for the Stoxx 600—some 2-3 points above historical averages. This means there is limited upside for equities—and little room for disappointments. Energy-related companies explain a large part of the downward earnings revisions. The rebound in the oil price will eventually lead to upwards revisions, but not until the second half of 2016 and into 2017. In addition, the situation for European banks remains difficult. They received some help from the new targeted long-term refinancing operations (TLTRO) package unveiled by the ECB on 10 March. But while banks can be expected to take out new TLTRO loans from the ECB or roll over loans from the previous TLTRO in order to earn a subsidy of 40 basis points (as long as the amounts borrowed are lent to the broad economy), the amounts involved will be comparatively small and hardly a game changer. In the meantime, European banks will continue to suffer from compressed net margins as a result of extra-low interest rates.