The chief investment officer of Lombard Odier Investment Managers says that while there is a lot to be uncertain about at this stage, problems mask a number of opportunities ahead.

There are plenty of uncertainties around and this seems to perplex, and even alarm, some investors. But the lack of clarity brings opportunities. In this vein, Jan Straatman, chief investment officer, Lombard Odier Investment Managers, takes a look at the investment landscape. The views of the author are not necessarily shared by the editors of this publication.

2014 will see slow global economic recovery. The US economy should speed up as new growth drivers emerge while monetary and fiscal policy stays supportive.

But in Europe the hoped-for recovery is optimistic. The repair of national balance sheets and restructuring of the financial sector casts a shadow over the region. Unemployment is too high and productivity growth too low. Growth will be anemic (at best).

The weakness of Europe’s financial sector is an enduring headache. Faced with balance sheet pressure and regulatory capital needs, banks - despite politicians’ wishes - are still reluctant to lend. Without more lending to consumers and SME’s, how can there be strong growth? The European Central Bank might lower interest rates further, but we wonder if this will work without the comfort blanket of fiscal stimulus, which governments have taken away.

In Japan the cocktail of quantitative easing, public spending and a weaker yen coined a new term: “Abenomics”. Although Prime Minister Shinzo Abe’s policy is a big step in the right direction, it may be too little, too late in the face of Japan’s vast debt problem. Japan needs global growth badly if it is to rebound strongly, but in that’s unlikely anytime soon.

Emerging markets’ growth advantage over developed economies has shrunk recently, but we expect that the gap will stabilise during the first half of this year and widen again in the second half, particularly for countries with solid economic policies. And keep an eye out for a faster-than-expected slowdown in China, as policymakers grapple with non-performing loans and the risk increases that policy is over-tightened.

And my savings…?
The risk of a major systemic quake, such as a government bond default or the collapse of a large bank, has subsided, thereby increasing confidence and risk appetites. The option to park money in “safe haven” bonds is no longer recommended: there is widespread acceptance that the trend of declining interest rates is over. The debate now is not if, but when, and by how much rates will rise.

The benign economic outlook, low interest rates, reasonable valuations and high liquidity, continue to support a slightly overweight equity position in the first half of the year. Despite the less rosy outlook for Europe, European equities are more desirable on relative valuation measures, such as dividend yield, and because they have lagged US stocks, which now price-in recovery.

Emerging markets are overshadowed by the smaller growth gap with the developed world, political uncertainty and risks from QE unwinding. However, later in the year, as the gap widens, we expect to reverse our underweight emerging markets position, into overweight. We’ll focus on consumer-related stocks, because of the long-term shift towards domestic demand and regionally we will favour Asian countries.

While it’s a consensus view to be underweight government bonds, the shift out of bonds is not finished. With flat to rising interest rates (starting from historically low levels) and with the risk of rising inflation over time, higher yields are justified. This reverses the alluring risk/return relationship from government bonds for the last 25 years. Over the next couple of years we expect marginally positive returns, but with (potentially large) downside risks.

Bond investors searching for yield will therefore look at corporate bonds. But investment grade bonds are too rate sensitive and offer insufficient protection. Investors should move down the credit curve and focus on the crossover zone between investment and non-investment grade. Convertibles will be another interesting alternative, as they combine exposure to both corporate bonds and equities.

The months ahead offer plenty of economic policy uncertainty.  There will be less synchronisation between regional growth cycles.  Expect a bumpier ride than 2013.

The impact of any policy mistakes will be huge. A long-term view on asset allocation makes little sense, it’s vital to constantly review the situation and take advantage offered by mis-pricings.