2016 Market Outlooks

Cover a variety of alternative strategies - all long/short funds

Originally published in the November 2015 issue

Jon Jonsson
Manager of the Neuberger Berman Global Bond Absolute Return Fund

“We expect turbulence in global markets to continue, as Chinese growth concerns and the approaching Fed hike are likely to keep volatility elevated. Despite aggressive stimulus measures by the Chinese government, economic data and markets have remained weak. However, from a market point of view, we believe a lot of weakness in China has already been priced in.
“With that said, we still believe developed market resilience can weather EM weakness. Most of the global growth weakness is confined to the manufacturing sector, which represents less than 20% of GDP in the US, UK and Germany.
“Looking toward 2016, the effects of recent fiscal and monetary stimulus should begin to feed through to the global economy. We expect global growth to remain moderate, but exhibiting increasing divergence. The US is facing short-term headwinds, but picking up strength as the positive effects on consumption should increasingly dominate the negative effects of oil prices.
“The European economy has entered a positive trajectory. Europe is benefiting from a weaker euro, less fiscal austerity, increased credit flows and lower oil prices. The eurozone is the region where we anticipate the biggest acceleration in growth in the coming quarters. If this scenario plays out, conditions are likely to be negative for government bonds. We have been clear that rates at current levels do not reflect fundamental economic reality.
“We continue to have overall negative duration, with a flattening bias in the US and a steepening bias in Germany.
“Non-agency RMBS remains one of our highest conviction sector overweights. Projected loss-adjusted yields are among the most attractive in the global fixed income universe and the duration risk is nearly zero. Furthermore, fundamentals for the asset class are relatively insulated from risk factors impacting other fixed income sectors. Low oil prices, for example, have a positive impact on non-agency RMBS fundamentals.
“While valuations in the HY market have become even more attractive, a number of overhangs are unresolved and will require more clarity for a lasting rally to occur. Credit spreads in general have been negatively impacted by poor Fed messaging, global growth concerns and a lack of liquidity. There are also idiosyncratic drivers weighing on the market, such as low commodity prices and high equity volatility.
“Even as default activity in the energy sector is expected to rise, future defaults for the overall HY market are likely to remain well below default rates implied by current valuations. We still feel concerns around oil, the Fed and China will weigh less heavily with the passage of time, which should clear the way for a partial reversion. Consequently, we recently increased our exposure to US and European high yield.”

Akshay Krishnan
Manager of the Stenham Macro UCITS Fund

“Historically, the majority of a macro manager’s returns have come from trading interest rates and currencies. While this playbook has traditionally served macro well, it has been difficult to trade in the period following the financial crisis. Central banks, led by the Fed, embarked on QE and forward guidance in monetary policy that effectively resulted in a suppression of volatility – especially in interest rates and currencies. Front-end interest rates in particular, a core instrument for macro traders, have been anchored close to zero in major developed markets, which removed a major tool from the trader’s toolkit.

 “As investors in macro for a long time, it is no great surprise discretionary macro traders struggled in this environment. While returns have been sluggish, risk management is inherent in the DNA of a discretionary macro trader and the strategy was resilient during this difficult environment. However, there is light at the end of the tunnel.
“We have witnessed currency volatility pick-up over the past 18 months, as monetary policy divergences between various global central banks became increasingly apparent. We believe monetary policy divergence will continue to be a theme in the medium-term, as the Fed looks set to hike and other major central banks, such as the ECB, do the opposite.
“Individual countries are now responding to their own economic fundamentals, as opposed to purely what the Fed is doing. Just as a fundamental stock picker requires dispersion in stock prices, a macro trader requires interest and currencies to behave in a fundamental manner. This increasing dispersion in currencies and interest rates on the back of monetary policy divergence will lead to more fertile trading opportunities.

 “After an unusually long period of calm in markets, there is now simply a lot more going on around the world. Markets aregrappling with commodity prices changes, questions around economic growth, and low yields in bond markets. Macro is the classic go anywhere, trade anything strategy. As volatility returns to markets, so does the opportunity to take advantage. It certainty does feel like we are returning to a more ‘normal’ phase for markets.”

Stuart Mitchell
Manager of the S.W. Mitchell Capital European Fund

“We remain very optimistic on the outlook for European equities. Recent company visits confirm our view that the domestic European economy is recovering faster than expected. We expect the recovery in domestic demand to continue to accelerate and for results to continue to beat consensus analyst forecasts in 2016.
“As the Eurozone moves closer to normalisation investors have struggled to accept how deeply companies and governments have restructured in the periphery and how a significant proportion of peripheral Europe’s productivity gap with Germany has now been eliminated.
“We continue to find the best opportunities in the more domestically orientated areas of the market. Banks, for example, is an area we believe the market has failed to appreciate the benefits of a rapid recovery in financial margins coupled with draconian cost cutting and easing regulatory pressures. We have focused on the strongest retail banking franchises such as Lloyds and Intesa where we believe returns will continue to rapidly return to pre-crisis levels during 2016.
“Europe remains compellingly valued with shares pricing in an unusually bearish decline in returns on capital into perpetuity. More strikingly, domestically orientated companies are trading at, in many cases, a 50% discount to their counterparts in the US. We believe investors will increasingly recognise the strength and sustainability of economic recovery helping European equities to trend higher in 2016 and to perform well on a relative basis. The potential for additional ECB stimulus would lend further support to the asset class.”

Charles Kantor
Portfolio manager of the Neuberger Berman US Long Short Equity Fund

“With modest but still positive earnings growth forecasted for the S&P 500 in 2016, the outlook for US equities remains, in our view, constructive but requires increasing selectivity.
“The corporate environment continues to be supported by solid cash flow generation and strong balance sheets, in addition to sustained profit margins and attractive returns on capital. In our view, these results are a reflection of the ingenuity of corporate leaders to push for advances in science while harnessing highly innovative technology applications to improve global business performance.
“Importantly, equity valuations are not overly demanding. Moreover, with the recent downdraft in equity prices, the valuation fulcrum has shifted – albeit slightly – resulting in an increased margin of safety versus the start of 2015. Specifically, equity valuations in the US already appear valued for very slow growth, tilting closer to the stagnation view of the world rather than a view for long-term normalisation. Thus, any sense that the global economy is not heading toward either a recession or secular stagnation could be very well received by investors in risk assets.”

Barry Norris
Manager of the FP Argonaut Absolute Return Fund

“We continue to believe that the most powerful equity narrative is the recovery of domestic Europe and, in addition, continue to find attractive idiosyncratic earnings surprise in single stocks. Somewhat ironically, given long-term scepticism of European equities, the biggest risks are now all exogenous: the Chinese economy, Fed funds and commodities.
“However, contagion threats should be limited by the delay of or even addition to monetary stimulus in Europe. As such, although volatility may remain elevated for a period of time, we remain confident in our fundamental positioning and see compelling opportunities on both sides of our book.”