This year has been a contrary one in a number of ways. After several years of developed market equity outperformance, Asia Pacific and emerging market equities have been the place to be in 2016.
Risk assets endured a disastrous start to the year, the worst year since the onset of the Great Depression. If investors had been told to put their monies into Asian and emerging markets back then, most would have baulked at such a suggestion.
However, now well into the final quarter of the year, these markets have been quite comfortably outstripped their developed market counterparts for the year-to-date.
This path has been echoed by sectors that have also been out of favour in recent years, but recovered strongly in 2016, namely commodities and energy. Some of this can be attributed to the US dollar because there is an inverse relationship between the value of the US dollar and oil and commodity prices.
When the US dollar strengthens, oil and commodity prices generally weaken. What we have seen during the course of this year is that the US dollar has softened. This was mainly because the forecasted, incremental US interest rate rises that were mooted at the beginning of this year never materialised.
It must be noted that we are still in the midst of a multi-year central bank experiment. Monetary policy has steered the markets and now currency fluctuations are having much more of an effect on markets than ever before. We are currently in a lowly world: low interest rates, low growth and low inflation.
This has led to an ongoing dichotomy between investors. In one camp, we have those focused on long-duration, quality stocks that provide sustainable growth and dividends on a multi-year basis. The consumer staples sector has been used at the vanguard of this approach. This includes stocks such as Unilever and Nestlé. The quality investor is seeking low earnings risk and low dividend risk.
Such has been the demand for these types of stocks, they have become relatively expensive. Investors who favour these relatively safer areas of the market are now having to pay higher prices for them.
However, on the flip side to this is the value investor. They are not prepared to pay for stocks they believe are expensive and prefer to take a contrary stance. They look for stocks that have fallen out of favour or which are being ignored by the broader market. Unfortunately for the value investor, this style of investing has been out of favour for a decade.
The trigger for value and cyclical stocks to start gaining momentum is not a rise in interest rates, although this could well be conducive to a period of outperformance. No, it is more the recent uptick in inflation that we have witnessed, particularly in developed markets. Value investors argue the catalyst for value to recover and for quality stocks to falter is for the market to believe that inflation is coming back.
