2013 In Review

The best performing equity market in 2013 was Japan, up 52%, whilst Brazil was the worst performing and down 18% over the year. The FTSE was up 14%, the US up 30% and STOXX 600 index (Europe) was up 17%.

Strong performance at the start of the year was helped by the FEDs asset purchase program and Fiscal Cliff negotiations passing without a hitch – the FTSE World returned 4.5% in January. This was the start of the great rotation of out safe haven assets into higher risk assets. Attention increased in Japan after returning nearly 10% over the month. The UK 10y Gilt was at 1.79% and the US at 1.69%.

February saw increased volatility due to the Italian elections, Moody’s downgrading UK sovereign debt to Aa1 and poor macroeconomic indicators from Europe. Despite this markets returned positive with government bond yields increasing.

In March equity markets had their first correction due to a funding shortfall in Cyprus, however, investors saw this as a buying opportunity with markets quickly recovering these losses. In April and May rumblings that the FED may begin tapering lead to increased volatility with gold being particularly hurt during this time whilst Chinese growth was starting to causes concerns. Japan has another standout month returning over 12%.

Despite all these concerns the FTSE recorded its 12th straight month of positive returns with the peak close coming on the 22nd May at 6840. However, with markets looking overbought and Bernanke spooking the markets on tapering fixed income and equity markets were sent crashing down in tandem in late May and the majority of June. The sell-off in the FTSE was some 800 points from peak to trough – nearly a 12% fall – wiping out the gains made so far. Government bond yield spiked with the UK 10 y moving from 1.68% at the end of April to 2.45% at the end of May, whilst the US 10 y moved from 1.67% to 2.49% over the period – a significant movement and depreciation in capital value.

Equity markets recovered somewhat in July with volatility remaining at elevated levels whilst gold stabilised as fears grew that the West was going to attack Syria. Bond indices did not recover their losses and remained fairly flat over the month but with increased volatility.

With bad news continuing to be good news (as this would mean that the likelihood of tapering would be decreased) October was a strong month for returns with the focus on data from the US.

However by December and with tapering finally announced the markets took this as a sign that the US was strong, with the data backing this up and the equity markets rallied into the end of the year. Bonds continued to perform poorly with the Barclays Global Agg ending the year down -4.41%, US treasuries down -7.8% whilst gold ended down 28%.

2014 Going Forward

Developed government bonds look more attractive than a year ago, but migration of the monetary policy in developed countries towards a more normalised position generates a low probability of a sustained rally in government bond prices. We don’t exclude a potential rerating of developed government bonds caused by deterioration in macro sentiment, but in our opinion this is going to be short lived. This expected behaviour is going to influence the whole fixed income spectrum but with different degrees of propensity.

Equities as an asset class will continue to be favoured relative to fixed income but we should not expect last year’s performance across the whole equity spectrum. The catalysts that will generate this year’s returns are going to be more complex than in the past, when the behaviour of investors was driven by a rerating of expectations. This year those expectations need to be met by increasing earnings momentum as well as M&A activity that should benefit from the opportunities given by access to low rates of credit and substantial cash holdings on corporate balance sheets.

US equities have the potential to continue performing in a low volatility regime but the catalysts that would determine this performance are influenced by the propensity by which the market participant are willing to move away from paying attention to Federal Reserve rhetoric and concentrate on the economic behaviour. Strategy selection is going to be crucial when incorporating this exposure.

The market expectation for UK equity is to continue the upside trend started last year fuelled by the economy performing in a higher growth environment (relatively speaking). The BOE new communication exercise with regards to the implementation of the monetary policy is going to have a large influence on the expected performance and can push the volatility into a higher regime as a monetary tightening decision could be brought forward and surprise markets. Also the market expectation with regards to the economy performance is high, as positive news continues to fuel the positive sentiment. Any short term derailment of the economy performance can generate a steep correction. Caution should prevail, as any realisation of the potential detracting factors above, can act together and force equity markets to dislocate.

Japan equity performance is highly dependent on the Abenomics efficiency combined with the BOJ unprecedented quantitative easing. The Japanese yen rerating that were a determinant of the equity performance during 2013 will have a lower impact going forward. We consider that the past year performance is going to be hard to be replicated during 2014.

Emerging market as a whole is no longer driven just by BRIC countries and deterioration in sentiment generated by some countries running budget deficits in conjunction with the tapering exercise that reduces the attractiveness of a carry trade will create a higher volatility regime. We also have to mention the short term liquidity issues arising from China. Depending on the amplitude of the current sentiment we appreciate that the evolution would have four layers of degradation: currency, government EM bonds, corporate EM bonds and EM equities. Depending on the sentiment deterioration we might see a contagion of the positive sentiment in developed markets. Opportunities might be found in some regions where steps were taken to realign the local economies to global trends of growth but it is difficult to pin point the catalyst that will drive buying pressure across the board.

There are a number of key events worth highlighting which will add volatility and could impact portfolio returns over 2014 as outlined below:

Key Fed Meetings Jan, Mar, Apr, Jun
Debt Ceiling Negotiations 7th February
European Elections 22nd May
Scotland Independence Ref 18th September
EU Bank Stress Test Results October
Brazil General Election 5th October
US Senate / House Elections 4th November

Overall looking forward, 2014 promises to be an interesting year where behavioural biases might have a higher influence in the market performance and where early detection of sentiment degradation is going to be crucial. We also take the view that risk management is crucial when budgeting risk by incorporating a framework that utilises a strategy approach to directional asset exposures.

Global Summary

The last month of 2013 turned out to be positive for developed market equities after some profit taking before the last Federal Reserve meeting. The event of the month that also affected both equities and fixed income was the Federal Reserve’s decision to start the tapering process in January after the US budget negotiations came to a favourable resolution. Once the tapering decision was made public, equity indices moved higher and reached new 2013 highs, with some indices making new all time highs and closing the month on an optimistic note. Yields on developed government bonds moved higher with UK and US 10 years yield trading above 3% as the Federal Reserve took steps towards a more normalised monetary policy.

UK Summary

In the UK the OBR’s forecast, contained in the annual autumn budget update to parliament suggested that UK growth would reach 1.4% in 2013 up from 0.6% predicted back in March and in 2014 a 2.4% rise. These updates backed by improving macroeconomic readings coming from manufacturing and construction sectors pushed equity indices higher, whilst speculation about an increase in interest rates sooner than expected moved UK 10 year Gilts above 3%.

European Summary

In continental Europe, finance ministers continued to make progress in reaching an agreement on a Single Resolutions Mechanism (SRM) and Single Resolution Fund (SRF) that will form the core of the banking union. In the same period Ireland became officially the first European Country to leave its bailout program. The economic readings coming both from developed as well as peripheral countries continued to surprise on the upside which fuelled market optimism.

US Summary

In the US the first half of the month was marked by speculation surrounding the FED tapering decision and negotiation around the US budget. Once the US budget was voted, the Federal Reserve announced that a first tapering round of $10 billion would be implemented in January 2014. The decision was saluted by the equity spectrum which recovered from the beginning of the month modest decline and continued the positive trend for the rest of the month with the S&P 500 closing on a new all time high. The yield on 10 year US government bonds climbed above the 3% threshold and will probably continue the upside trend for the foreseeable future as the tapering process unfolds.

Japan Summary

It was another positive month for Japanese equities with Topix gaining another 3.5% whilst Nikkei 225 closed above 16,000 for the first time since 2007 and had the biggest yearly advanced in more than 4 decades. The 2013 economic reforms launched by the Abe Government and the loose monetary policy have been the main drivers of Japanese equity performance.

Emerging Markets Summary

It was another month of underperformance coming from emerging markets as FED tapering speculations and in the end inception generated a higher level of volatility, the Chinese financial system was under intense pressure as the seven day repurchase rate spiked 140 basis points to 6.6% and forcing the People’s Bank of China to supply $32.9 billion of short term funds. Going forward, as the tapering process is implemented we expect elevated levels of volatility to characterise the EM space with inferior risk adjusted returns compared to developed equities.