CIO's view: Moving ever closer to “normal”

By KleinWB, Tuesday, 7th January 2014 | 0 comments

Having remained optimistic throughout 2013, I believe that 2014 will continue where 2013 left off and at this point am not advocating any changes to the “positive positioning” we have in place for discretionary client portfolios. I expect 2014 to be another positive year for global equities with bond markets once again struggling. Equity valuations are no longer cheap but equally they are very far indeed from what would be considered ‘bubble-like’.KBI078 white Thumbnail0

We are now over five years on from the worst of the global financial crisis and the global economy is moving from the post-bubble phase to a phase of ‘self-sustaining normal growth’. I expect all of the large developed economies to grow more strongly in 2014 than they did in 2013.  The improvement is likely to be strongest in Europe, with the economy returning to positive growth this year.  The picture is slightly different in Emerging Market economies, where growth has been reasonably strong for some years, but has faded somewhat in recent months.

Equity markets have of course correctly anticipated this improvement, with strong returns in 2013.  The likelihood for 2014 is that equity markets will match earnings growth (rather than exceed it), producing positive but more modest returns than 2013.  In contrast, the outlook for bond markets is negative, as central banks, and particularly the US Federal Reserve, move away from their policy of massive liquidity creation. Alternative asset classes such as commodities had a less positive 2013 but I suspect they will be more competitive in a diversified portfolio this year. I am all too aware that these optimistic views are much more consensus today than they were 12 months ago and the degree of bullishness amongst investors is increasingly high, which has historically been an uncomfortable place to be!

I have no doubt that there will be challenges to markets as the year unfolds and in this blog I will focus on the key risks – both upside and downside! – to markets this year.

The following are scenarios or risks we consider in descending order of likelihood for 2014:

 Risk 1: Economic growth turns out to be much stronger than expected:

Such an outcome would certainly be a major negative for bond markets and would exert more of a two-way pull on equity markets which could lead to a flattish out-turn for equities. We witnessed such an environment in 1994 where stronger than expected economic and earnings growth were offset by sharply rising interest rates. In this scenario much will be written about central banks being ‘behind the curve’ as bond markets create headlines of an ‘inflation scare’. 

Risk 2: Equity market valuations reach expensive levels

In this scenario, ‘easy money’ from global central banks continues to be funnelled into equity markets and other risk assets rather than into the real economy (which itself doesn’t accelerate as expected but rather continues to muddle along).  Just as in 2013, equities deliver acceptable earnings and dividend growth but are turbo-charged by a further expansion of P/E multiples into expensive territory leading to a stellar 20-30% equity year.

Risk 3: Emerging Markets materially disappoint

In this scenario the struggle of 2013 would turn into a meaningful ‘actual’ issue, such as materially slower than expected growth in the Chinese economy or an unexpectedly negative market reaction to ‘tapering’ (incidentally, I believe that to have been last year’s story). While the coincidence of a material slowdown in emerging economies occurring at the same time as developed economies are accelerating would be very rare, it would be very messy for equities and positive for developed market bonds.

Risk 4: Europe IS the new Japan

Recent nascent optimism about a genuine recovery in European economy quickly fades as the green shoots of growth wither and die. ‘Japanification’ of Europe becomes the jargon phrase of the year (replacing ‘tapering’!).  The ECB again becomes the focus of attention and the euro weakens materially. Peripheral Eurozone bond markets also become vulnerable as core defensive bond markets come back into favour.

Risk 5: A year of 2 or maybe 4 halves!

Some combination of some or all of the above could occur leading us to expect a very dynamic roller-coaster type year. We have been there before!

Summary: 2014 similar to 2013

I expect that 2014 will most likely be a similar but less spectacular year to 2013 echoing many similar trends with the strong exception that I believe Emerging Markets will perform much better in 2014. Valuations (in Developed equity markets) are no longer cheap but I remain confident that earnings and in particular dividend growth will be even more important in this year than they were in 2013.    Risks abound of course – both upside and downside – as I’ve outlined above but the bottom line is that I expect that investors will reap solid – if unspectacular – gains from equity markets this year.


Noel O'Halloran, Chief Investment Officer

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