Last year was marked by major divergence between the U.S. and the rest of the world, in everything from economic growth to the returns of major stock and bond indexes. In 2015 we will likely see the convergence of performance with the rest of the world rushing to catch up with the U.S. The U.S. is one of the most introspective nations in the world, and that is our strength; we are willing to criticize ourselves in public and—even though at times it feels like politicians are slow to get anything done— change course and correct the major problems holding back success.
The rest of the world isn’t so open and honest with itself.
Outlook: International Developed
Europe and Japan have major problems; both overspend on social services, nationalism often trumps the greater good, and deep xenophobia has led to internal cultural riffs and declining population. These are all problems the U.S. has faced and to some degree resolved. Europe and Japan will also resolve these issues, but it’s going to take longer.
The dominant powers of continental Europe, France and Germany, as well as the current government in Japan, understand that not addressing these issues means permanent decline. We believe, 2015 will be a big year for Europe and Japan in terms of taking the next steps to build stronger economies. These steps include: Quantitative Easing, further union of banking regulation in Europe and reform of byzantine corporate structures in Japan. Greece may end up exiting the Union this year, and it will make noise, but that doesn’t really matter in the long term, as Greece is a very small part of the overall economy. The bottom line is that if investors see Europe and Japan beginning to tackle their problems, expectations for growth to converge with that of the U.S. should rise along with the markets.
Outlook: Emerging Markets
Investors often joke that emerging markets have been the future since the 1970s: Lots of promise and little delivery. That was less true in the 10-year period from 1998 to 2008, but emerging markets have been disappointing from both growth and return perspectives since the Great Recession.
The rise of the middle class in the emerging markets, from China and Vietnam, to India, Brazil and the Philippines is real. The same pattern the West saw during the Industrial Revolution, of farm workers moving to cities to work in factories, then using education to move from factories to middle class management, is happening around the world. The new middle classes are making these countries more stable and is re-orienting the engine of economic growth from low-cost exports to domestic consumption. The strength of this transition will be felt in 2015, as the new middle class standard of living in emerging markets continues to converge with that of the U.S. and the rest of the developed world. While emerging markets tend to be volatile, the long-term trends bode well for performance of both equity and fixed income markets.
Last year was a year of great divergence; 2015 will likely be a year of convergence. As we start a new year, we are looking beyond the next 12 months at the next 60 months. Predicting the performance of any one market in any one year is a fool’s game. The key to being a successful investor, as one of my mentors once said, is finding the biggest wave and having the best surfboard. I believe the biggest wave of the next 60 months is the convergence of the U.S. and the rest of the world, and the best surfboard is a diversified portfolio.
