Asset allocation is at least as important as individual share selection. So where shouldyou be putting your money? Here's our monthly take on the major asset classes.
Watch nickel
Last year was a lousy one for raw materials, with the IHS Material Price Index sliding by a fifth. Prices could well slide further in the months ahead. China is the key driver of demand for base metals, notably copper, coal and iron ore, and the economy is likely to have grown by just 7.4% in 2014, the slowest annual rate since 1990. The property and credit bubble continues to deflate and the authorities appear reluctant to embark on a massive stimulus to blow up the bubble again, suggesting a strong pick-up in the coming year is unlikely. Demand growth elsewhere is not set to soar, as the global recovery is still tepid. Supply, meanwhile, looks healthy. But watch nickel, says Colin Hamilton of Macquarie: it is "the one commodity where we are extracting less from the ground than we are consuming every day". Metals prices have also fallen far enough to make mining firms enticing for value investors.
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Agricultural commodities, while inevitably subject to weather-based fluctuations in the short term (see page 6), are in a structural bull market thanks to the decline of arable land amid rising populations. As futures can be very volatile, fertiliser and farm-equipment stocks are the best way to play this theme.
Too risky
Government bonds remain historically overpriced and too risky for long-term investors, considering also the state that developed-economy finances are in. The corporate-bond market also looks like one to avoid. Not only has the rise in all markets made them expensive, but the junk-bond bubble could soon meet a pin: the over-indebted energy sector. Leave well alone.
Look abroad for value
UK house prices rose by 7.2% last year, according to Nationwide. This year prices still look set to rise, reckon forecasters, but only by around 3%-4%. The government appears to have wiped the froth off the market with its review of the mortgage market, which tightened lending criteria and tempered demand for mortgages. Political uncertainty is likely to dampen demand, as a Labour victory would probably bring a mansion tax. Meanwhile, an oversupply of top-priced new-builds and a potential undersupply of mobile Russian oligarchs are likely to undermine London prices. Even if prices actually fall a tad, however, the market remains overpriced, as it never even reached a reasonable level compared to earnings after the last downturn. Investors should continue to look abroad for value.
Stick with Japan
"There remains a fundamental disconnect", says Liam Halligan in The Sunday Telegraph, "between Western share prices pumped up by printed money and an unconvincing economic recovery." The recovery in the West will gather momentum in the US, but Europe looks in danger of sliding into a Japan-style deflationary slump. However, central banks in Europe and Japan are set to deliver more quantitative easing, and liquidity injections always end up in asset markets, so we remain buyers of European and Japanese equities, which are still reasonably valued by historic standards.
Emerging markets will face another bumpy year as higher interest rates in the US sucks capital out of the asset class, while the commodities slowdown also bodes ill for some. But valuations are reasonable. Oil importers with big domestic markets, such as the Philippines and India, areworth a look.
Tanking oil
Oil has continued to tank, plunging towards $50 a barrel this week and rattling markets again (see page 4). It has now slumped by 55% in just six months. Demand growth is still tepid and the glut keeps getting bigger. US shale producers are still gushing, so oil cartel Opec, which hopes to put the shale operators out of business by making it uneconomical for them to drill, won't cut output any time soon. Oil could slump as far as $30, reckons Dennis Gartman of the Gartman Letter. That should eventually give global growth quite a fillip. Natural gas, as we note on page 7, is also in for a rocky few months, but should rise over the long term.
Buy gold for insurance
Volatile risk markets have lifted the yellow metal off its four-year lows around $1,150 an ounce, seen in November. And while this week's jitters have seen the uptrend continue, gold looks set to struggle as higher real US interest rates diminish its allure and further reduce the likelihood of inflation taking off in 2015. But inflation could still make a comeback in the next few years. And a nasty accident, such as a messy eurozone exit by a southern European state, can hardly be ruled out. So keep some gold as portfolio insurance.
The outlook for silver, also near a four-year low, is complicated by the fact that it is an industrial metal as well as a monetary one, and consequently dependent on industrial demand. It is also extremely volatile. For gamblers only.
