Global Markets Outlook 2014
2013 was a year of contrasts, with strong performance in equities balanced against relative weakness in bonds.
But what lies ahead for the economy and the markets as we enter 2014?
We see favorable developments in equity markets, including an acceleration of the U.S. economic recovery, resurgence in Europe, growth and reform in Japan, as well as viable investment themes in emerging markets. On the other hand, our views on global fixed income bond markets are more guarded.
So what does this mean for you?
In an investment climate like the one we expect to see in 2014, having a disciplined, prudent investment approach becomes more critical than ever. Investors will need to be realistic in their return expectations, while our investment managers will need to be highly conscious of the potential risk/return trade-offs in the decisions they make.
We are here to help you do your homework.
Read, watch, and listen to the insights of several of our senior investment professionals as they provide a more in-depth look at key asset classes and sectors.
WILL REFORM = GROWTH?
- While growth continues to be driven by a small group of core countries, we expect even the most beleaguered markets to emerge from recession by the end of this year.
- Unemployment rates remain stable, but the patchy and concentrated recovery will create few jobs.
- Investment remains a weak spot. In particular, bank lending remains limited as these institutions shrink their balance sheets to boost capital. At the same time, new infrastructure spending is constrained due to high budget deficits.
- Inflation is expected to remain low in the midst of a weak recovery.
- We expect the European Central Bank (ECB) to remain accommodative for the foreseeable future. It surprised the markets with a rate cut in November 2013 but is unlikely to take further action in the near term. It may, however, seek to strengthen forward guidance. A further round of long-term refinancing operations is possible in 2014 to counter falling bank reserves.
CONSUMERS ARE SPENDING
- It is clear that confidence is returning gradually to the regional market, and this should feed consumer spending. In fact, we are already seeing better retail sales data.
EYE ON BANKING REFORM
- The ECB is embarking on its comprehensive assessment of the major eurozone banks and will become the sole regulator of these institutions in 2014. This process includes an asset quality review and stress test, which should provide the ECB with an opportunity to address weaknesses in the European banking system.
CHANGING THE COURSE OF JAPAN'S DEFLATIONARY MINDSET
- Economic data continue to be largely positive, as short-term fiscal stimulus and monetary easing by the Bank of Japan boosted growth. We expect further monetary easing in 2014.
- Inflation is expected to accelerate over the coming months on the back of rising electricity and food prices. However, we believe the Bank of Japan is still significantly more optimistic about its inflation goal than the markets. In our view, the 2% inflation target is unrealistic, unless the bank expands the scope of its asset purchases to include riskier assets, such as real estate. We expect wage inflation in 2014 as more Japanese firms announce and commit to wage increases.
THE FEEL-GOOD FACTOR
- Prime Minister Abe should be able to take advantage of his unprecedented approval rating and Japan's feel-good factor from winning the Olympic bid to push through his reforms.
PROPOSED SALES TAX
- The planned increase in the sales tax could provide a drag on the economy, though a recovery in exports should help cushion the impact.
SIGNS OF A POSITIVE DOMESTIC ECONOMY
- Economic data suggest that Japan is moving in the right direction. To believe in a long-lasting recovery, domestic consumption has to be a significant driver of incremental demand.
- Price gains from the recent rally have already provided a wealth effect, which should underpin consumer spending.
- The market rally over the last year is evidence of foreign investor interest. The next step is convincing investors, who have been disappointed by Japan's history of failed policy initiatives and typically short market spikes, that the current environment can be sustained.
- To some extent, lasting market gains will depend on greater Japanese domestic participation and interest from long-term investors overseas. Such sticky investments would be a positive for the markets over the long run.
JOBS + HOUSES = A WINNING COMBO
- Fiscal headwinds likely peaked in the fourth quarter, and signs point to faster housing starts and business fixed investment in the months ahead. We expect the pace of growth to quicken and accelerate a bit further over the course of 2014.
- Resilient employment growth in the face of ongoing uncertainty in fiscal policy reinforces the FOMC's view that the underlying strength of the broader economy is on the rise.
POLITICAL GRIDLOCK AND THE BATTLE OVER SPENDING AND TAXES
- After raising the U.S. debt limit in October, Washington is likely to reach its debt limit again on or about February 7, 2014.
- Markets may become increasingly nervous as the deadline approaches. However, given the experiences of the government shutdown in October, political gridlock associated with the debt ceiling debate and upcoming budget negotiations is less likely.
HEALTHY CORPORATE PROFITS
- If the U.S. and global economies continue to recover in 2014, fueling further corporate earnings growth, history tells us that credit spreads should tighten as Treasury yields rise.
- The question in the U.S. market now is: What do companies do with all their cash?
HOW FAST WILL INTEREST RATES RISE, AND HOW HIGH WILL THEY GO?
- We expect the Fed to shift its monetary policy mix as it winds down asset purchases. Consensus suggest that rate hikes won't come until 2015, and even then, they will be gradual.
- Fed communications will need to contain market expectations and not threaten the recovery. The Fed's ability to raise short-term market rates while maintaining an enlarged balance sheet will be challenging.
- Interest rates should increase over time — incoming Federal Reserve Chairman Janet Yellen's dovish bias has reinforced the expectation that rate hikes will be steadily paced.
TAPERING IN THE NEAR TERM
- Tapering is likely to start in 2014, perhaps as early as the first quarter, accompanied by a modest rise in U.S. Treasury yields over the course of the year.
ENERGY INDEPENDENCE AND REINDUSTRIALIZATION
- There is growing evidence of onshore trends as companies move production closer to the design of goods and services and away from China, where real wages are skyrocketing and inventory lead times are growing.
- Greater U.S. competitiveness, in terms of real wages, is leading the way for the U.S. manufacturing sector.
- We are bearish on the price of oil but excited about the prospects for U.S. shale production. U.S. energy needs, at times, have been held hostage by the Middle East. We believe that this will change and the U.S. will eventually become self-sufficient.
- The U.S. controls its own destiny regarding energy supplies.
UNCERTAINTY IN CHINA AND INDIA
- China is not falling off the cliff in the way we thought. We do not think it is accelerating; we think it is stabilizing.
- Although slower Chinese growth has implications for emerging market countries, we are constructive on China's ability to rebalance its economy from investment to a more sustainable, consumption-led model, albeit at a measured pace.
- Despite macro problems in India, from an equity perspective, there are good valuation opportunities at the micro level in certain sectors, such as technology, where India operates at a global level. There are local opportunities as well, particularly relating to infrastructure.
FRONTIER MARKETS SHINE BRIGHT
- Frontier markets have been especially strong in the equity space over the last year, while broader emerging markets have struggled with capital outflows.
- Africa and the Middle East are key, commodity-rich regions that will see economic activity driven by rising urban populations and a young workforce.
POLITICAL RISK AND SOCIAL UNREST
- We also expect political change to grow in importance as several markets that have recently experienced social unrest enter election cycles. Policymakers face difficult decisions, and investors are likely to be increasingly discriminating in allocating capital.
- Deregulation is critical to the Third Plenary reform plan, as it will change China's long-term growth potential to a higher-quality and more sustainable trajectory. The time line for achieving these goals, however, is still far off—2020 in most cases—meaning that actual implementation will likely remain slow for the next several years.
FROM COMMODITIES TO THE RISE OF THE CONSUMER
- This investment theme remains intact, in which the key drivers are declining poverty; expanding upper and middle classes; rising consumption; and, most potently, real wage growth. There are many ways to play the rise of the emerging market consumer, including Internet growth, consumer durables, protein consumption, home purchases, retail spending, and banks.
- Looking at Asia, Internet usage has taken off faster compared with the U.S., and e-commerce in China is booming.