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Wealth Managers See More Equity Gains; QE Tapering Remains Number One Issue

Tom Burroughes

11 December 2013

As wealth managers around the world start to wind down towards the holiday season, thoughts inevitably turn towards what the following 12 months have to offer. Recent months have seen a strong focus on the crunch issue of when, and not just if, the US Federal Reserve decides to switch off the monetary taps.

As at the time of writing (11 December), the MSCI World Index of developed countries’ equities shows total returns – reinvested dividends and capital growth – of 23 per cent since the start of January; the MSCI BRIC Index, by dramatic contrast, is down almost 1.9 per cent over the same period. And the contrast between those figures highlights one of the biggest shifts over the past 12 months – the reversal of fortunes between emerging and developed markets. Developed markets took some of the hardest hits from the 2008 financial crisis, while the younger economies of Brazil, Russia, India and China had a spring in their step. But the slowdown in Fed quantitative easing, and the prospect of an end to ultra-cheap money, has thrown a cloud over emerging markets – for the time being, anyway.

So what to specific wealth management houses make of all this? This article gives a by no means exhaustive list of some of the prognostications out there. WealthBriefing will be sure to publish as many of these as possible, particularly those views that are unusual, or highly detailed and arresting in some way.

Legg Mason

David Hoffman, managing director at Legg Mason subsidiary Brandywine; he sets out the anticipated positioning for the Legg Mason Brandywine Global Fixed Income fund.

“We expect structural stagnation or weakness in commodity prices due to China’s economic composition shift, fostering a continuation of the tempered inflation environment globally. Though, our recent research suggests that China can continue at 7% growth for the next decade while appropriately shifting the composition of growth away from new fixed asset investment,” he said.

“Stimulus tapering will be back on the table for the Fed as that central bank gets increasingly uncomfortable with unintended consequences. Whether developed economies can stomach significantly higher term interest rates is something to which we will pay close attention - this summer’s experience suggests not. We forecast modestly better global growth in 2014 and we tend to be more bullish than markets on global growth, but if safe-haven interest rates sell off again in 2014, we would likely look to lengthen duration exposure in those markets,” Hoffman said.

“We believe Japan’s economic policy will continue to gain traction in creating appropriate inflation levels and speed up nominal growth. However, we expect the yen to remain flat to lower against G3 peers as part of the mechanics of stimulating nominal growth. We live in a beggar-thy-neighbor world with each exporter fighting for restrained global demand growth, so we are closely watching for interventionist central bank policies around the world.”

Thomas Becket, chief investment officer, Psigma

“As the curtain comes down we can see that 2013 has been the year of the equity, with developed market stock indices up strongly for the year, led by Japan and the US, which have gained 46 per cent and 28 per cent, respectively. The UK FTSE 100 has lagged, “only” gaining 15 per cent, but that performance has far outstripped the returns in emerging markets, where the broad market index is in negative territory for the year. Core government bond markets have also performed poorly, with most producing negative returns, although certain areas of corporate credit markets have delivered good returns for our clients,” the firm said.

“2014 seems set to be another year of extremely supportive monetary policy. The US Federal Reserve will imminently start to reduce their quantitative easing programme, but we do not expect the next head of the Federal Reserve, Dr Janet Yellen, to be anything other than highly accommodative with regards to interest rates,” it said.

“Indeed, we expect interest rates to be on hold across the major developed world economies for the whole of 2014. We have seen some optimistic forecasts for UK growth next year, which have been interpreted as being a trigger for UK interest rates to start rising. We are unconvinced and think that the beginning of 2015 is more likely and sensible, as we can be sure that the Bank of England and the politicians will be highly reticent about potentially dulling the immature economic recovery after five barren years,” he said.

“As we look around the world for the obvious risks next year, most can be found in the bond markets. If interest rates remain ultra-low and monetary policy remains very loose, this will primarily be because the world’s central bankers are comfortable with the outlook for inflation. Indeed, one of the arguments in favour of supportive policy is the fact that inflation rates are falling across the world. The proverbial fly in the ointment could come from a rise in inflation expectations, driven either by commodity prices or income gains,” it said.

“Given that China appears destined for a reduced resource-intensive economy in the future, we do not expect a surge in commodity prices, although gains are possible after a lacklustre few years. We are also unconvinced that there will be pressure on corporate managements to increase wages, due to the amount of spare capacity that remains in the labour force. However, any fear of rising prices could curtail the stimulative efforts of central banks, increasing pressure on bond yields. If bond yields were to rise too quickly there is the likelihood of a negative reaction across other markets, not least as the recovery we are enjoying is fundamentally built upon the availability of cheap credit,” it added.

Swiss & Global and GAM

Global equities

“In the face of all the talk of “bubbles” appearing, could it be that markets stay stronger for longer into 2014? Buoyed by falling oil prices underpinning a low inflation environment, bond markets could well remain quiescent and equity markets happy. A virtuous circle might then ensue, giving sufficient confidence to a more optimistic corporate sector to finally increase levels of investment. In turn, this would support further reduction in unemployment, particularly in Europe. In this scenario, any gradual tapering should hold fewer fears for investors,” said Andrew Green, fund manager of the GAM Global Diversified Fund and GAM UK Diversified Fund.

Emerging market equities

“Investors’ expectations for emerging market equities are low, however, emerging markets will have a better start to 2014 than to 2013, with many economies now in recovery phase. Valuations are attractive and stocks have high upside potential. Given the potential change in US monetary policy, selectivity is key; not all emerging markets will profit equally. Additionally, elections in several countries will likely lead to volatile markets. We specifically see opportunities in China, Korea and Eastern Europe,” said Erdinç Benli, fund manager of the JB Global Emerging Markets Stock Fund.

Asia equities

“Markets have been giving Japan too much hope and credit for Abenomics while discounting China on policy uncertainties.  But with the reform announcements post-Third Plenum, the gap should close over time given how cheap Chinese equities are now.  The reforms are necessary and the details on implementation will emerge in the next few months.  Korea and Taiwan will continue to benefit from better sentiment on China as well as a recovery of the global economy.  We still like Southeast Asia in the medium to long-term, but political risks and uncertainties remain elevated in the short-term in Thailand and Indonesia,” said Michael Lai, fund manager of the GAM Star China Equity Fund and GAM Star Asian Equity Fund.

US equities

“Trading at a P/E of 14.6x for 2014 and a P/B of 2.6x the US equity market’s valuation is in line with historical averages. In 2014, we expect earnings growth to accelerate, however much of that is already reflected in consensus earnings estimates. We are not ruling out a short-term correction after the strong performance in 2013,” said Aleandra Walker-Ott, fund manager for the JB US Value Stock Fund.

“However, the market is well supported by a growing economy, benign inflation and the appointment of Janet Yellen as the new Fed Chairman, which bodes well for continued easy monetary policy – even if we do see tapering. We favour sectors/stocks leveraged to global growth that benefit from the rebound in manufacturing and capital spending such as industrials and information technology. We also see value in certain financial sub-sectors like insurance and some banks, where a steepening yield curve should be supportive,” Walker-Ott said.

European equities

“European equities are set for a continued strong rise in value in 2014 and most investors have not participated in 2012 and 2013.  The market will likely rebalance towards those businesses that have the strongest growth, both cyclically and structurally, and will reward those managers that are the most active in their style,” said Niall Gallagher, fund manager of the GAM Star Continental European Equity Fund and GAM Star European Equity Fund.