Low for longer most likely scenario in 2014 – iShares
Stephen Cohen, Chief Investment Strategist for iShares EMEA, looks at three possible scenarios for the global economy in 2014 and pinpoints equity and fixed income strategies for investors to consider in these instances.
Developed equities have been the clear winning asset class in 2013, driven by the US and Japan in the first half of the year and a European turnaround in the second. Rather than a great asset class rotation, there were several mini rotations within asset classes. In fixed income, there was a rotation from broad funds into short duration, and in equities, from emerging markets into developed markets.
55% probability for low for longer
The outlook we think is most likely in 2014 is one where monetary policy remains accommodative. Growth will improve yet remain below trend, with consumers bound by subdued wages.
In this instance, potential investment strategies include:
• With political uncertainty in the US, minimum volatility strategies can provide a smoother way of accessing US equities
• It’s essential to differentiate between ‘emerging markets’. Countries with strong current account fundamentals, such as Korea and Taiwan, should see more resilient performance amidst Fed taper concerns, as should China. A minimum volatility strategy for broad emerging markets exposure may provide more attractive risk-adjusted returns
• European peripheral bonds have been a direct beneficiary of the ECB rate cut, and offer carry compared to core Europe
• Emerging markets continue to develop as a source of income as their growth outlook matures. Valuations for dividend payers outside of the US remain attractive.
• Despite long-term tightening, high yield spreads are still above historical default rates
• Data continues to suggest sentiment improvement in Japan and a potential deflation exit. The increasing correlation between equities and Yen weakening means that currency-hedged strategies are still opportune
Will growth break out? 25% likelihood
We estimate there is a 25% likelihood of a ‘growth breaks out’ scenario. In this scenario, corporate spending and bank lending increases in Japan and Europe, and stimulus-driven China grows as the country progresses on its reforms.
• In the event that growth breaks out, emerging market equities will benefit as investors re-allocate to the asset class.
• Brazil has been an underperformer in 2013 due to local monetary tightening and a deteriorating fiscal position. But beaten-up Brazil will offer value if emerging market growth positively surprises the market in 2014
• If growth breaks out, rates will rise faster than current expectations. This suggests that in fixed income, investors’ focus should be on high yield and especially in shorter duration bonds and interest rate hedged strategies
A 20% chance of imbalances tipping over
An alternative scenario, albeit the least likely, is for global economic imbalances to tip over. Europe’s sentiment led recovery fades and there is an emerging market funding crunch as liquidity is withdrawn. China’s ambitious reform agenda comes at the expense of growth to create such a scenario.
• Minimum volatility equities could offer cushioned access to global equities in a risk off scenario
• Gold could provide a crisis hedge despite a challenging 2013 for the metal so far
• If rates remain low the search for income will continue and dividend stocks with a defensive tilt and attractive valuations could prove popular