Investors have been worried about many uncertainties this year, including the Greek debt crisis, the much awaited Fed rate hike, China’s slowing economy, etc.
Such sentiment may spill over into 2016 as liquidity, volatility and the dollar index remain high.
The European Central Bank originally planned to end its quantitative easing (QE) program in September 2016.
However, inflation is still below target. The ECB is also concerned about the slowdown in China and other emerging markets.
Last week, it announced that it would continue with its QE measures. Japan is likely to follow the same path.
Further easing in Europe and Japan will add to the low interest rate levels in other Asian countries. The already abundant global capital pool will get more liquidity.
However, the short supply of financial assets, resulting from the abundant capital, will push up asset prices, and potentially cause overvaluation, even bubbles, for some asset classes in the mid-term.
And while liquidity remains high, investor concerns, policy uncertainties and overvaluation of certain asset classes may create more turbulence in the market.
Investors should keep calm, focus on fundamentals, and prepare for volatility.
Meanwhile, the US dollar has been strengthening for some time. The dollar index, along with the real exchange rate, shows that the valuation level is close to a four-decade average.
We expect it to keep strengthening, but at a slower pace.
With further QE in Japan and Europe, equity markets will see more capital inflows in 2016. The improvement of corporate governance in Japan will make companies there more attractive to global investors.
As for the bond market, even though the Federal Reserve is normalizing its monetary policy, the low interest rate environment in other economies will support the demand for fixed income products. Thus, the yield of government treasuries is unlikely to rise sharply.
Equities will provide major returns to an investor’s portfolio. However, fixed income will play a key role in improving the portfolio’s stability and higher-than-cash returns.
Investors may add corporate bonds or other emerging market bonds into their bond portfolio as they seek better returns.
This article appeared in the Hong Kong Economic Journal on Dec. 7.
Translation by Myssie You
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