ING IM’s Valentijn van Nieuwenhuijzen sees markets in transition
Valentijn van Nieuwenhuijzen, head of Strategy at ING IM, sees a shift in investor focus from central bank inspired liquidity towards economic and corporate profit growth as market drivers.
Since May this year, markets have been in a transition phase. Investors are aware that the unorthodox policies the US Federal Reserve have applied for years will now gradually be ended. The pivotal role of central banks in supporting the economy will, slowly but surely, become smaller. For several years, markets have been driven to a significant extent by the large supply of liquidity. Asset classes that attracted much liquidity were thus hit hard in May and June by the prospect of the money supply being slowly cut off. Emerging (debt) markets were the main victims.
After the Fed surprised in September by postponing the tapering of its bond-buying programme, the markets priced in a delay until next year. Following a slightly more aggressive than expected tone by the Fed and macro figures in October (ISM, payrolls) that were better than expected, the Fed may well decide to start tapering after its upcoming meeting on 18 December. However, we still consider March 2014 to be the most logical time, also in light of the federal budget negotiations to be held in December.
Regardless of whether the Fed starts tapering this year or next year, we expect that the impact on most of the financial markets will be less than it was in May and June. A key difference is the starting point. At the start of the taper talk in May, the 10-year interest rate was still below 2%. As it has since risen by 80 to 90 basis points, we believe that the risk of an equally steep rise over a comparably short period is much lower than in May and June.
Meanwhile, most of the tapering risk has been priced in and markets also seem to better understand the difference between tapering and tightening (i.e. rate hikes). Under Janet Yellen, the new Chair of the Federal Reserve, the forward guidance principle will be refined further, and rate hikes still appear to be at least two years away. If the onset of tapering no longer leads to investors expecting substantially more and/or earlier rate increases, there will be much less of an upward pressure on long-term interest rates, and therefore much less of a negative impact on risky assets like equities and real estate compared to earlier this year.
Although central bank policies worldwide will continue to be accommodative, there will be a transition away from liquidity and towards economic growth and corporate profit growth as prime market drivers. We expect the economic recovery to continue, contributing to higher earnings. The perception of systemic risks in the markets will also further decline. That may contribute to lower risk premiums on equities. Capital flows continue to play a role that is not to be underestimated. Flows between the various asset classes instigated by large global money managers will play an important role. We expect that the rotation from cash and ‘safe’ bonds towards equities and riskier bonds will continue in 2014.
Equities continue to be our favorite investment, although there is of course no assurance that the solid returns that we have seen this year will carry on into 2014. In our opinion, Europe presents the best opportunity for improvement. While growth in the Eurozone remains slow, the countries in the periphery are expected to catch up. The same applies for their corporate earnings, which may be headed for a strong recovery from their low levels. The decrease of the spread on peripheral government bonds may well continue. Emerging markets, however, are vulnerable. They have attracted so much foreign capital since the Fed deployed its unprecedented liquidity measures that there is a real risk of a reversal in capital flows.