How to dealing with divergence

How to we can do deal with divergence it can be good for all businessman.

ivergent economic growth and monetary policy underpin our 2015 base case.
We expect tightening financial conditions in the U.S. and U.K. due to a pickup
in growth and improving labor markets. Lackluster growth and low inflation
expectations support looser monetary policy elsewhere. Falling oil prices should
support growth in most countries and hinder it in a few.

Financial markets and economies are diverging as well. The financial cycle has
leapfrogged the business cycle in most countries. Asset valuations and investor
complacency are high, likely triggering bursts of market volatility. Bonds are
becoming less effective diversifiers for equities due to ultra-low yields.
Emerging markets (EM) are really diverging markets. We prefer countries
implementing reforms to open up their economies; a little reform can go a long way
in boosting asset values. We like hard-currency EM debt due to relatively high
yields. Equity valuations are cheap—but free cash-flow growth is hard to find.
How to deal with all this divergence? It calls for very active risk management and
extending investment horizons through longer holding periods. The main point is
to have a plan: Readiness rules in 2015.

GROWTH AND POLICY

U.S. growth is on an upswing.
We expect the Fed to start
raising rates in 2015 and the
yield curve to flatten.Eurozone growth could surprise
on the upside due to rock-bottom
expectations. The European
Central Bank (ECB ) looks likely
to deliver on market hopes for
full quantitative easing (QE).Japan’s monster bet on monetary
stimulus brings both short-term
opportunities (equities) and
long-term risks (debt blowout).hina is digging deeper in its
monetary policy tool box to
stave off an even bigger growth
downdraft as it attempts
reforms—a balancing act.

OUR INVESTMENTS

We like Japanese and European
equities due to cheap valuations
and monetary boosters. We favor
U.S. cyclicals over defensives as
the Fed tightens.
We prefer credit sectors such
as U.S. high yield and European
bank debt over sovereign debt.
We like hard-currency EM debt,
and favor U.S. Treasuries over
other safe-haven bonds.
We like income-paying real
assets such as property and
infrastructure, but want to get
compensated for being illiquid.Our contrarian idea: beatenup
natural resources equities
as a hedge if U.S. dollar
strength fades.

AIR POCKETS

Nominal risk-free rates should
stay low for long. This means low
rates of return—unless assets
become oversold or investors
use leverage.
The foundation for a strong U.S.
dollar is in place, yet the journey
to long-term appreciation is
tricky. Expect a bumpy ride.Volatility is set to return. Elevated
valuations and a voodoo-like
belief in momentum raise the
cost of mistakes. The key is to
have a plan beforehand.Stocks and bonds could fall in
lock step, challenging traditional
diversification. Relative value
strategies and alternative
investments can help.
First Words
Some 120 BlackRock portfolio managers and executives
discussed what is in store for markets next year at our
2015 Outlook Forum in mid-November in London. The
semi-annual event, the seventh of its kind, was marked by
intense investment debates in small and large groups.
One exercise featured a pre-mortem: “It’s mid-2015 and one
of your investments has blown up. Which one, and how could
you have hedged it?” We pushed ourselves to re-examine
these lower-conviction positions, many of them pro-growth
or relying on price momentum. We debated our high-conviction
investments in another—less morbid—session and have
sprinkled them throughout this publication.
The reason for introspection: The financial market cycle has
moved ahead of the economic one in many countries, partly
as a result of QE. A torrent of monetary stimulus did not just
suppress volatility, but pulled forward financial activity as well.
Valuations in most markets are rich and investor faith in
monetary policy underpinning asset prices is high (pages
6–7). We reminded ourselves that periods of high returns
are usually followed by low ones; the trick is picking the
turning points. Bursts of market volatility from the current
low levels are likely—and have the potential to wrong-foot
investors (page 8). Easy hedges are tougher as stock and
bond prices may start moving in the same direction. Also,
yields are so low that bonds risk losing their role as shock
absorbers.Growth scares and tumbling resources prices have led to
sharp falls in inflation expectations. The worry for central
bankers: Even medium-term inflation expectations (which
discount swings in energy prices) are falling fast, particularly
in the eurozone. This suggests central banks alone cannot
prevent disinflation. Increased public spending may be
needed to reflate economies—but many governments are
unwilling (or unable) to loosen their purse strings.
The global recovery from the 2008 financial crisis has been
an unusually tepid one. Nominal growth in 2015 is expected
to be below the 15-year trend in most economies, according
to International Monetary Fund (IMF) forecasts, with the U.S.
and Japan notable exceptions.

Many pro-growth assumptions—rising wages and inflation,
a behind-the-curve Fed and an uptick in global growth—did
not pan out in 2014. GDP forecasts have a history of downward
revisions. See the chart to the left. The oil price decline, if
sustained, could reverse this trend in 2015 as it should boost
real growth in major economies. See the chart above.
The price fall should dampen headline inflation in the
developed world. This could strengthen calls for monetary
stimulus in weak economies and help keep a lid on bond yields
in stronger ones. Lower energy prices benefit many EM nations
due to improved trade balances, reduced government subsidies
and lower inflation. India, Indonesia and Thailand should be
winners, we believe. Oil exporter Nigeria could be a casualty.