2013 Review
Firstly, some numbers. The FTSE World All Share Index rose by approximately 20% during 2013 with the S&P and Dow Jones US indices rising by 30% and 26% respectively. The FTSE Euro First rose by 16%, and within that the Dax (the German index) rose by 20%. The FTSE 100 index rose by some 14%, its best gain since 1999.
In Japan, the Nikkei rose by an outstanding 57% (but unless hedged against currency movements, for UK investors around half of the gain was lost because of the sharp fall in the Yen). In China, the Shanghai Composite fell 7% while the Turkish and Brazilian markets fell by 18% and 16% respectively. However, not all of the so called developing economies fared badly, with Pakistan’s relatively small market demonstrating considerable volatility on the upside.
Currency movements have generally been relatively modest. Sterling strengthened a little against the Dollar and the Euro, but not to any fundamental degree. The Yen has however fallen by 22% as a deliberate result of Government policy to try to reintroduce a modest degree of inflation into the Japanese economy after years of damaging deflation, one of the key methods used to achieve this being massive quantitative easing which is still ongoing. A number of developing markets have seen currencies fall sharply for other reasons, including for example Brazil and South Africa, in part at least as a consequence of “taper tantrums”, to which subject we will return later.
The total return on fixed interest investments has been slightly positive but yields on ten-year US Treasuries and UK Gilts have risen from, broadly, under 2% to around 3%, a 50% increase. This has clearly had a negative impact on their values, again reflecting the potential impact of a return to tighter monetary conditions.
Gold has been a dreadful investment over the last year. Other commodity funds have also lost value.
All of these moves have been driven by a number of factors, the principal one being the continuation of accommodative monetary policies in key economic blocks, i.e. the USA, the EU and Japan. There is little doubt that these policies have led to a general rise in the prices of equity assets, reflecting the expectation that as economies pull out of recession and begin to grow again, scope for companies to increase earnings and dividends emerges. Indeed, many companies have taken the opportunity of loose monetary policy and low interest rates to dramatically improve their balance sheets and it looks as though some have, as a consequence of being able to borrow for the medium term at low rates, reduced their dependency on bank borrowings.
Towards the end of last year, evidence that monetary policy is beginning to react to improved circumstances began to emerge, in the USA with the announcement that tapering of the QE programme is to commence and in the UK, the Funding for Lending scheme to provide funding for the housing market was stopped, although the scheme remains open for business lending. These moves, of which US tapering is clearly the most significant, represent the start of a process of monetary tightening that looks set to continue into the new year.
2014 Outlook
We are confident that monetary policy will remain a key driver of financial markets during 2014, the pace of change in turn reflecting the rate of economic recovery. It looks reasonably likely that the economy of the USA will continue to recover and that the support given for some years now by the accommodative policy will slowly be withdrawn. This is not a suggestion that US interest rates will rise soon as there is considerable scope to tighten money without raising rates. In the UK, where quantitative easing ceased some while ago, the odds are still against interest rate rises this year but we may well see some progress to interest rate normalisation in 2015, particularly if growth were to accelerate excessively, in turn putting significant upward pressure on inflation or if unemployment were to fall at a rate consistent with ‘bubble’ conditions.
In terms of economic recovery, the Eurozone lags behind the US and the UK: any monetary tightening here is unlikely for the foreseeable future. This is also the case in Japan where the Government came to the concept of quantitative easing late in the day and there remains more to be done to reinvigorate the Japanese economy and to remove the deflationary threat. In this environment, the US Dollar looks set to strengthen.
We believe that China is set to broadly maintain strong growth particularly if the benefit of that growth begins to be better distributed across the population.
For us, emerging markets are a conundrum. Many appear to offer good value to investors when compared with developed markets but not all emerging economies are sufficiently robust to cope with tighter US monetary policy, the effects of which are felt very widely – hence the impact of ‘taper tantrums’, weakening the currencies of fragile economies.
How should investors react?
Our main concern for 2014 is that fixed interest markets will continue to react adversely to the prospect of tighter money leading inexorably towards increased interest rates. This may lead to fixed interest investments offering a negative return during 2014 and while, as part of a balanced portfolio, fixed interest investments clearly have a role, at this juncture we continue to underweight the sector within portfolios (a view that we have consistently held for some time now), except for those investors who are very income focussed or where the income accrues without deduction of income tax, i.e. within pensions and ISAs, thus enhancing returns.
We consider that index linked investment continues to have a role for long term holders seeking to balance equity risks taken elsewhere. However, it may be that 2014 will not be a vintage year for this sector.
Turning now to equities, in developed markets the trend towards higher profits and dividends continues. While to an extent this is reflected in current share prices (particularly perhaps in the USA), it remains our view that investors should remain overweight in this sector, focussing in particular on a spread across developed markets. For reasons touched on in the 2013 review, many companies are in good shape and we expect to see long term investment by companies building during 2014, assisting their medium term development. As we move towards the end of this month and into February, we will see an increasing flow of companies announcing their 2013 results, into which announcements will be built their observations on current trading and the future outlook. We believe that we may see some reasonable surprises on the upside although the rate of divided growth may slow a little as companies use cash for investment.
We touched on concerns regarding emerging markets a little earlier and, given the uncertainties we are minded to remain underweight in this area for most, although high risk investors might wish to consider taking a small stake and building on it as the year goes on. As for commodities, as recovery builds we anticipate that demand will increase so building positions here, again as the year progresses, may have merits.
We do not see cash as an investment asset class representing a worthwhile element within portfolios during the current year unless we see an equity bubble develop in which case switching an element of one’s portfolio into cash on a temporary basis as a tactical manoeuvre might prove worthwhile.
Summing up, our view is that the policy of investment principally in equities, where reasonable yields and sensible growth potential are to be found, represents a sound way forward with any volatility perhaps providing useful opportunities for further investment. While we do not expect 2014 to hold the same potential for rapid growth as we have seen last year, we are quietly confident that equity returns in 2014 have the potential to be sensibly positive.
Budget 2024