2014: A good year – Saxo Private Bank’s Knuthsen says
The prospects for Europe and Japan are not as positive as in the US, but both should be able to look forward to accelerating growth, according to Saxo Private Bank’s CIO Teis Knuthsen.
The past year has been an extraordinary investment year with exceptional returns on developed markets equities. For bond markets, the party was more subdued and longer-dated European government bonds returned less than 2%. Emerging markets generally fared poorly, and both EM bonds and equities were asset classes on which to be underweight.
The overall performance has been well aligned with my recommendations last year. With the exception of the troubled summer period I have been recommending an overweight of equities relative to bonds, and through most of the year also an underweight of emerging markets. Through most of 2013 I have argued that increasing global growth and an unusually expansionary monetary policy would result in higher stock prices. This theme remains valid and guides my overall approach to the financial markets heading into 2014.
Global recovery to continue in 2014
The short-term business cycle is characterised by progress for large parts of the global economy, and a range of economic indicators is pointing towards higher growth in the coming months. This is especially true for industrial production, but also private consumption is on the rise. At the same time, the negative effects from a tightening of fiscal policy during the past few years is fading. Finally, business investments seem likely to be a much more positive driver than has been the case in recent years. The rise in growth is taking place against a background of low and falling inflation, which increases both the strength of the recovery and the probability that it may continue.
Again this year I expect the US to be a growth leader, and there is good reason to believe that it will not only surprise on the upside in the coming months, but also that we are moving towards above-trend growth. Industrial production is at its highest level ever, corporate earnings are record high, the housing market is in a multi-year recovery and the labour market is improving. Fewer unemployed and rising real wages are pointing toward increased consumer spending, and combined with a less negative impact from fiscal policy (which in 2013 reduced overall growth by almost 1.5 percentage points), 2014 could be a year where the primary drivers of the economy all contribute to higher growth. Importantly, in December Washington agreed on a budget deal for the next two years, which should reduce the risk of a repeat of last autumn’s political crisis considerably.
Large rotations roll back
The decade from 2002 onwards was largely characterised by a shift from developed countries to emerging markets and a super-cycle in commodity prices. These rotations are starting to roll back , helping to improve the outlook for the US economy in particular .
One can rightly speak of an budding production renaissance for the economies in the West. This trend includes an insourcing of production from emerging markets that in turn is driven by technological change as well as an energy renaissance. On the technological side, the trend is towards increased focus on the use of IT, robotics and 3D printing. On the energy side, it is mainly the results of the increased use of shale gas that has lowered energy prices significantly. The decline in energy prices is most pronounced in the United States and provides a comparative advantage, which again helps attract foreign investment.
Low inflation, falling commodity prices, low interest rates and rising growth is a positive combination for many Western economies, which may result in a long-term recovery and high corporate earnings. In contrast to this, many emerging market economies struggle with rising inflation, rising interest rates and slowing growth. I therefore reiterate the recommendation again this year to underweight emerging markets.
The prospects for Europe and Japan are not as positive as in the US, but both should be able to look forward to accelerating growth. In Japan, last year’s monetary shock therapy bore fruit in the form of both rising inflation and accelerating growth. The first quarter of this year looks positive from an economic perspective, but part of this growth will be driven by a planned consumption tax hike in April and it will be difficult to assess the economy’s real strength until we reach the second half. I look for a further monetary easing in the second quarter, just as a continued weakening of the yen seems likely.
Last year’s positive trend in the Eurozone is also expected to continue. In general, I view the euro crisis as a closed chapter, and I expect a gradual improvement from here. There is no shortage of structural challenges, not least in relation to reducing unemployment, and a real boom is a long way off. Nevertheless, there is reason to believe that the worst is behind us. A sustained recovery could give rise to a significant repricing of the European equity markets.
For the European Central Bank (ECB) 2014 will be a challenging year. Inflation fell sharply in 2013, and I expect a further decline in the coming months. That drop will take us close to deflation, and many commentators are likely to equate falling inflation and economic recession. The truth is, however, rather that slowing inflation is due to falling energy and food prices, which again helps to restore lost competitiveness and lift disposable wage income.
In the second half of the year, inflation should again begin to rise again. At the same time, the ECB is conducting a stress test this year of close to 130 major banks in preparation for the work towards a banking union. The ECB fears that the stress tests will reveal more problems than it can handle, and is therefore working intensively to strengthen banks’ capitalisation. In order to mitigate the negative economic consequences of this in the form of reduced lending, and in light of falling inflation, I expect further easing of monetary policy in the coming months.
Our short-term business cycle model is still pointing to higher activity levels for the global economy. Combined with a monetary policy that is designed partly to lift both growth and asset prices, I maintain a recommendation to overweight risk in general and of equities vs. bonds in particular.
I have a positive view on the economic outlook for many Western economies in 2014, and in particularly the United States, where a manufacturing and energy renaissance provides a real opportunity for significant growth progress. This increase in growth takes place against a background of low and falling inflation, which is usually good news for stock markets.
We probably won’t repeat last year’s bull market, but also this year a continued rise in P/E multiples should result in positive returns. I also expect a continued decline in gold prices.