Iveagh’s Chris Wyllie reviews predictions of a year ago
Chris Wyllie, CIO of Iveagh, sees the performance of emerging markets over the past year as the key source of disappointment against predictions that were made in early 2013.
What We Said Last Year
“2012 was all about more of the same but 2013 will be an inflection year when we enter a new phase, heralding important shifts in some previously well-established market trends. Deleveraging and austerity will not disappear, but the contest between inflationary and deflationary forces will finally be settled, with the world economy entering a reflationary phase.
The immediate impact of this will be that investors will regain some faith in growth and become more relaxed about taking risk, creating a rising tide for equities. Cyclical strategies will perform well, including Europe and Emerging Markets, and a trend in relative underperformance by US equities will become established, exacerbated by political foment there. However, investor concerns about US budget talks will be mollified by a surprise bounce-back in European growth in the Spring, helping to prolong a stock market rally into early summer.
However, the silver cloud has a black lining, in the form of government bond yields. An initial surge in bond yields is taken in good heart, seen as reflecting a healthier growth environment (even though it leads investors to be disappointed by the returns in their corporate bond portfolios). However, concerns begin to crystalize about how and when QE will be reversed. The gilt market and sterling will be amongst the hardest hit, as political risks mount and the UK loses its “safe haven” status. Positive real yields are restored to bond markets, and as a consequence, investors are surprised to find that their inflation hedges – such as gold and inflation linked bonds – perform less well than they expected. The US dollar remains quite firm and Japanese yen weakens considerably, fuelling further gains in Japanese equities.”
|US economy onwards and upwards, UK rebound, Europe out of recession and Japan Abenomics||Win|
|Increased risk-taking, higher equities||Volatility down, equities up||Win|
|Europe equities perform well||Eurostoxx +21%||Win|
|Emerging Markets perform well||EM Index -5%
LoseUS equities underperform
|European growth surprise||Europe out of recession in H2||Win|
|Concerns about QE reversal||“Taper tantrum”||Win|
|Gilts suffer||FTSE Gilts Total Return -5%||Win|
|Sterling weak||Trade-weighted index slightly down (flat vs USD)||Draw|
|Gold falls||Price -28%||Win|
|Dollar “quite firm”||Trade-weighted index up 3.5% YTD||Win|
|Yen weak, Japan equities strong||Nikkei +57% in yen terms, +26% in GBP||Win|
We’re pleasantly surprised to see we only got one thing clearly wrong this year, although it was quite a big one: we got the performance of emerging markets and US equities the wrong way round. Pretty much all the other calls, which centred around further improvement in the growth outlook and the implication of a move away from QE, were very much in the right ball park.
What We’re Saying This Year
The runes are a little harder to read in 2014 than in 2013, but we think many of the same themes will carry over. The global economy has positive momentum going into 2014, and it is fairly well underpinned. In the light of this, the winding-up of QE will remain the big story. It’s likely that bond yields will continue to melt up, but we don’t expect a major bond market rout, because inflationary pressures remain subdued, allowing central banks to continue to cap bond yields, mainly through the instrument of very low base rates and forward guidance.
The combination of broadening global growth and the first steps in normalising monetary policy will set the stage for further gains from equity markets, but investors may be surprised to find that 2014 is one of those rare years where the early months are not the best. The first half of the year brings a consolidation/correction phase for equities as they await clearer signs of positive earnings momentum. Eventually this does materialise, and emerging markets finally have a year of both relative and absolute performance. European equities also do well on the back of rising margins.
In terms of currency, it is the year of the pound, which keeps pace with or even exceeds gains in the dollar, as investors recognise that the economy is experiencing a pre-election boom. The euro and emerging market currencies weaken. The strong pound weighs on UK equities, which underperform in relative terms due to the translational and transactional currency effects. One sub-sector of equities which does well is listed private equity, which continues its recovery courtesy of higher NAVs and falling discounts. Overall, 2014 turns out to be a more complicated year than 2013, and is at times frustrating for equity investors. However, in the end satisfactory returns are made, and equities beat bonds again, as they did in 2013.
At Iveagh, we construct our portfolios to withstand the error of our forecasts, so we do not put too much store by predictions. Nevertheless, we think that, as 2014 progresses, it will become clear that 2013 was an inflection point, and the trends which started then are becoming embedded. This particularly applies to bond markets, which will continue to be a drag on returns. One inflection which we hope will occur in 2014 is a turn up in relative performance of non-US markets, principally Europe and emerging markets. We hope that we do not find that we are, once again, “waiting for Godot”.