Summary views from Pavilion’s Investment Outlook – Q4 2015

Uncertainty surrounding the likelihood of a federal reserve interest rate hike continues

  • U.S. inflation remains low with no indication that it will pick up over the near-to-intermediate term given low commodity prices, a strong U.S. dollar, weak payroll numbers and the potential for the government to rein in healthcare costs.
  • Worldwide inflation remains low despite accommodative monetary policy and low rates globally. Both Europe and Japan are struggling to reach inflation targets.
  • A further disincentive to a U.S. interest rate hike is that it could destabilize emerging market economies that in aggregate have borrowed an estimated$5.7 trillion dollars ($3.1 trillion in bank loans and $2.6 billion in bonds).
  • We anticipate that investors will continue to focus on the Fed’s next move, with nothing likely to occur in 2015 except for increased volatility.

Inflation Remains Very Low

Source: Bloomberg

China rebalancing its economy toward consumption and services and away from manufacturing and investment-driven growth

  • China’s GDP growth remains robust, but is moderating to more sustainable levels. Representing one-third of global economic growth, a slowdown in China negatively impacts world growth and, in particular, other emerging market countries that export to China, as well as the commodities markets.
  • As China transitions to a consumer- and services-oriented economy, commodity exporting countries are affected most negatively, particularly countries exporting metals, which is highly correlated to industrial activity. There will be winning industries and economies coming out of the transition but change of this magnitude creates uncertainty and volatility.

China GDP Growth Moderating

Source: IMF

U.S. Large cap equities growth and value styles

  • U.S. large cap growth stocks began outperforming value stocks noticeably in 2015, largely as a result of strong performance from Healthcare and IT (traditional growth sectors), and very weak performance from the Energy sector, which makes up a larger portion of the value index. For the prior five years, the performance of growth and value stocks has not been significantly different.
  • The global growth forecast looks more uncertain today, as a result of China’s slowdown and a belief that the Chinese economy may be worse than reported by its officials. Many other EM countries are suffering from low commodity demand, ample supply and low prices. A possible rise in U.S. interest rates could be problematic for some Emerging Market countries as well. While China accounts for a small percentage of U.S. exports, it is the world’s second largest economy, so any slowdown will be felt in the U.S. as well. A stronger U.S. dollar relative to most major currencies is hampering U.S. exporters. On the positive side, U.S. consumers, which make up two-thirds of the U.S. economy, are benefiting from both the stronger dollar and lower energy prices. The potential impact of a rise in U.S. rates is an overhanging fear in the U.S., with some belief that it could dampen overall growth. We believe the Fed will be judicious on its interest rate decision and the change likely will be so small that it will have minimal impact on U.S. growth expectations.
  • Valuations between growth and value stocks are fair.

U.S. Large Growth vs. Value Price/Earnings Ratios—Growth and Value Stocks Appear Fairly Priced

Source: Russell cap-weighted indices

 

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