Where to Invest 2014

Where to Invest 2014 - Investment Market Outlook

2014 is expected to be a year of modest, fragile growth and little inflation with accommodating central bank policy supporting markets.  However, we may be moving to a stronger recovery and the potential for investors to make money in this stage of the cycle with more investment in cyclical sectors.  In a world where markets are still heavily influenced by changes in central bank policy diversification is important to protect investor returns.  Youth unemployment in Europe remains at a very high level, the economic recoveries in the US and the UK remain fragile and political and military tensions between China, Japan and South Korea are starting to simmer.

World Economy

• The Organisation for Economic Cooperation and Development (OECD) has recently downgraded its forecasts for global economic growth.  In May it was looking for growth in the global economy of 3.1% in 2013 and 4% in 2014. It has now downgraded those forecasts slightly – blaming the uncertainty caused by the problems in the US mentioned above – so that it now expects growth of 2.7% and 3.6% respectively.   The only real certainty is that some countries will do well and some badly and whilst the global economy is improving, local disputes and problems are bound to impact on individual countries’ economies.

• US Equities are expected to continue their recovery throughout 2014.  There are prospects for positive growth, the housing market is recovering, the current account deficit is improving and unemployment is falling.  Business confidence is also improving.  We are positive for US equities in 2014.  Technology stocks are seeing increased demand recently.  The Federal Reserve wants to employ “optimum control” techniques to achieve its objective of price stability (2% inflation) and full employment (6% unemployment) and has suggested rates will be close to zero until 2016.  Tapering of quantitative easing means that the Federal Reserve believes the economy can withstand less financial support.  The US Congress agreed a budget deal to reduce the government budget deficit by $20bn to $23bn but the debt limit has not been increased, so a slowdown in February could be on the cards. 

• UK Equities are expected to continue their recovery throughout 2014, although the UK is still running a large current account deficit.  Growth is expected but at a slow pace.  The news for the UK is actually quite mixed.  Unemployment is falling but wage growth is also falling.  House prices in the South East have been rising at a fast rate but consumer confidence has wavered, resulting in the first fall in retail sales for a year.  The Bank of England said that without a pickup in business investment and improvement in the trade balance, recovery is not guaranteed.  Inflation is also at its lowest level since 2009.  If the recovery in the housing market and employment market rises faster than expected, we could see an interest rate rise.   We are positive for further UK equity growth, given government measures to stimulate business investment and trade.

UK Economy

• In his Autumn Statement, Chancellor George Osborne predicted growth for this year of 1.4% with 2.4% expected in 2014. These figures were higher than those predicted in the March Budget – when there were still real fears about the UK slipping back into recession – and confirm that the UK is gradually recovering from the world financial crisis.

• The phrase George Osborne used was “responsible recovery” and we can expect to hear plenty more along similar lines as the run up to the May 2015 General Election gathers pace.  The coalition government seems determined to go to the country with a message of ‘we are gradually recovering so don’t let Labour ruin it’, so we do not think there will be any shocks from the Chancellor and also not a lot in the way of pre-election giveaways.  We expect to see a lot of encouragement for new businesses in general and manufacturing in particular. Also, there is likely to be more coverage of the Prime Minister’s dealings with China as he tries to position the UK as China’s favoured trading partner in Europe.

UK Housing Market

• Most forecasters are expecting a similar level of growth in 2014, with the National Institute of Economic and Social Research opting for 5% growth. Some commentators are slightly more cautious, worrying that interest rate rises (which would seem likely at some point in 2014) may depress the market.   Looking further ahead it is generally expected the house price rises will slow down.

European Equities

• Have gained confidence and positive news is out there.  The interest rate cut by the European Central Bank in November 2013 has helped to keep deflation at bay.  Germany has fared much better than France recently and the ECB has set out plans for a banking sector union, of which it would be supervisor for 130 banks.  The prospect for growth from the Eurozone is mildly positive.  The region has low inflation but that is driven by high unemployment, weak wage growth and limited consumer spending.  Equities are cheap but there are risks involved.  Consumer confidence is increasing.

Japanese Equities

• Saw solid performance during 2013 but not in Sterling terms as it grew against the Yen.  It is generally accepted that the Bank of Japan will maintain its aggressive monetary policy and ramp up quantitative easing in 2014.  This has boosted confidence in Japanese equities and it seems they are doing all they can to get to the inflation target of 2%.  Weakness in the Yen will boost exports for Japan and news is positive in terms of growth for 2014. 

Asia Pacific

• Regions are worried over the effect tapering in the US will have.  The question is whether Asian markets can make the transition to a world where quantitative easing (and a driver of inflows to the region) are less important and phased out.  Our view is that larger regions such as Taiwan and South Korea will be more resilient and benefit from the US economy.  Smaller and less liquid markets such as the Philippines and Thailand are more challenged and more likely to see volatility.

Government Bonds

• Have really ticked along for the past year and that is not expected to change for 2014.  Inflation is benign and central banks will act gradually to remove monetary stimulus.  Interest rate hikes are likely to be years away.  However, volatility in US treasury markets and a rising US Dollar will have a big impact on emerging markets bonds.  We are neutral in our outlook for government bonds.  There is pressure on longer dated Gilt yields to increase.  The growth outlook for these bonds is improving slowly.

Corporate Bonds

• Have fared better than expected over the last year, with not as many outflows into equity investments as was predicted.  The outlook for corporate bonds is good for 2014, especially from high yield bonds where defaults are remaining low and there are no real inflationary issues on the horizon.   However, for lower quality bonds such as CCC rated bonds talk is that the spreads are not adequately compensating investors for the possibility of default.   Investment grade corporate bonds are also on track for a positive year despite volatility in the market. 

Emerging Markets

• Equities have seen a sustained sell-off and now look cheap in some sectors.  The question is whether you are catching a bargain or a falling knife.  For those people already invested in emerging markets funds there is a dilemma – do you realise the losses and lock in against further falls, but knowing that you will not be able to take advantage of a rally?  The problem with emerging markets is two-fold.  Firstly, the Federal Reserve in the US tapering quantitative easing. 

• This means there is not as much money around, much of which was previously going into emerging markets, pushing assets and currencies higher.  By tapering quantitative easing, less money is flowing into emerging markets and investors are worried over huge emerging markets fund outflows, the risk of currency and banking crisis and widespread contagion.

• The difference in emerging markets during these falls is that strong current account balances have cushioned against many of the problems.  Growth has not collapsed and the International Monetary Fund is predicting emerging markets growth of 5% between 2014 and 2018.   For developed economies the expectation is 1.5%.  Additionally, consumers in the emerging markets are becoming richer and developing a more westernised lifestyle.  We also need to appreciate that tapering from the US is not an end to quantitative easing, just a structured reduction.

Emerging Markets Bonds. 

• Re-pricing of US monetary policy is the most serious risk for emerging markets in 2014 and it is expected that China will dominate.  Reduced bond prices and the expectation of reduced asset prices will drive the US Dollar higher and hurt emerging markets.

• China has seen a slowdown and this has had an effect on emerging markets too.  The outlook is good for China, although slower growth between 4% and 8% is expected in 2014.  The reason for the slowdown is the targeted reforms by government to rebalance the economy away from exports in favour of consumption.  Success is expected over the next year or so. 

• The ‘Fragile Five’ are the markets in India, Turkey, Brazil, South Africa and Indonesia.  These markets are vulnerable as they are reliant on external funding.  Turkey’s deficit problem is an issue, given it is a potential EU member and is a big trade of partner in Europe.  The central bank does not have enough reserves to support the Lira for much longer and we are also seeing political dramas.  The central bank doubled interest rates in January 2014, sending the Lira to an all-time low against the US Dollar.  India is making the best progress with its current account deficit falling.  Turkey and South Africa are not faring as well and all 5 countries have political elections in 2014.  Our view for emerging markets is that there are gains to be had if you take a selective country and sector view.  For example, we see value in China, with Brazil and South Africa looking good medium to long term investments.

Inflation

• Has been widely talked about over the past few years because the only way out of the western world’s debt problems is a mix of financial repression and a healthy dose of inflation.  Developed world inflation is remarkably under control, despite record levels of stimulus and money printing.  The main reason inflation has not appeared is that the money has not entered the real economy.  Banks are flush with cash but many are not making new loans available. 

• We have seen some relaxation of lending standards recently though.  It is also hard to find creditworthy borrowers in countries such as Spain, Greece, Cyprus and Ireland and those countries are the most susceptible to deflation.

Interest Rates are expected to remain low. 

• The prediction is that the UK will be the first to increase rates, closely followed by the US and then Europe and Japan. 

Currencies

• Are topped with expectations of strength from the US.  With the UK running a large current account deficit, Europe considering sub-zero deposit rates and Japan following a policy to weaken the Yen, the US Dollar faces the fewest headwinds.

Gold

• Suffered losses of 30% during 2013, making losses of 37% since 2011.  If tapering continues and interest rates rise then gold prices could fall again.  Inflation, economic and equity market turmoil are drivers for precious metal, but investors are still wary.

Commercial Property

• Has been strengthening, especially in the UK.  Better economic conditions should support rental income growth, although the actual asset valuations are likely to come under pressure if Gilt yields rise.  That said, commercial property has both an income and asset growth investment perspective and as markets recover, business will expand and demand for commercial property will rise.  We are positive about commercial property, especially in the UK, especially when held as part of an overall portfolio of investments.