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.