Will next year see a continuation of steadily improving global growth or is a shock in store? Rebecca Jones asks six experts where they feel the risks lie.
Kerry Craig, global market strategist, J.P. Morgan Asset Management
The second half of 2013 saw a build-up in economic momentum around the globe, and this should continue into 2014.
In an environment of strengthening economies and better prospects for earnings growth, the biggest risk investors face is very much a political one, whether caused by policy error or by other political events.
As the Federal Reserve starts to wind down its quantitative easing (QE) programme, the pace at which it scales back asset purchases will be key. Cutting too fast may result in a rapid rise in bond yields and mortgage rates, potentially dampening economic growth. The Fed will be keeping one eye firmly on the housing market throughout its tapering process.
What will be the biggest risk to markets in 2014?
In Europe, the European Central Bank’s actions have removed almost all of the tail risk from the markets; however, 2014’s asset quality review has the potential to send ripples through the financial sector and further disrupt an already fractured system.
Meanwhile, although many of the key elections in European countries have passed, there is still the risk of a political flare-up or political brinkmanship that could reignite old instabilities.
But the risk is not all in developed markets. Fears of a hard landing for the Chinese economy proved to be unfounded in 2013 and the data over the last few months suggests stabilisation in China. But as the politburo seek to transition the economy from an investment-driven model to a consumer-driven one, and to gain control over the shadow banking system, there is potential for a policy error that may slow growth in the near term more than anticipated.
Ed Smith, global strategist, Canaccord Genuity Wealth Management
Quantitative easing has valorised equity prices by forcing investors to accept lower compensation for equity risk while doing very little for their fundamental value.
We think it is telling that asset prices rather unaffected by this portfolio balance channel effect have not moved ahead this year in the same manner.
Indeed, copper – frequently referred to as the barometer of global growth – has fallen. Although a structural shift in the supply-demand balance has weighed here, copper arguably more accurately reflects the outlook for global industrial production.
Assuming the Federal Open Market Committee (FOMC) starts tapering in January and decelerates the purchases through to December, our modelling suggests that positive equity returns will be difficult without higher earnings growth.
We are pleased the gap between equity prices and levels implied by macroeconomic indicators has narrowed but the tenacious stagnation of personal income, combined with headwinds from emerging markets, will likely mean that we will endure a low growth environment for another six months.
An unanticipated tightening of monetary policy by way of a faster rate of tapering could trigger substantial equity volatility. This has a higher probability than many investors realise – although the new FOMC chair may be a dove, the rotation of voting seats next year will result in a natural hawkish/QE-sceptic shift. Since 1990, equity market sell-offs triggered by unanticipated tightening are also accompanied by bond market sell-offs, as we saw in June.
Asset allocators must work harder to find true equity diversification and avoid breaching risk mandates. We believe direct infrastructure plays are still a good choice with a low correlation to equities in all market conditions, as well as vehicles which look to isolate interest rate differentials.
James McDaid, investment manager, GAM
It is easy to be swept along with rising stock markets and improving economic data; however, one must remain cognisant of the main driver of the US economy - Mr and Mrs Smith on Main Street, USA.
The confidence rising house prices inspires in the mind of the general public, and the resulting increase in spending on items such as washing machines and televisions, has a massive impact on a large swathe of company earnings. A reversal in this rise could knock the broader economic recovery off course and it is a risk that should not be ignored.
Sticking with company earnings, some of the market rises over 2013 were on the back of forecast earnings growth over the periods ahead (based on an improving economy overall).
Of course, there was also the ‘QE forever’ mind-set; however, what happens if the expected earnings growth does not actually materialise? The expansion in valuation multiples we have witnessed could easily reverse, resulting in portfolio losses on equity holdings.
It is widely accepted that QE will begin to wind down through 2014. Quite what impact this will have on a multitude of financial assets is, to some degree, guess work. With a switch taking place at the helm of the Fed, and with the nature of unprecedented support over the last few years, there is a risk of policy error seriously denting investors’ confidence in these decision-makers.
One hopes that Janet Yellen brings a cool, calm and collected head to the table, and that the QE withdrawal will be a long-term, well considered process. The transformation from a price insensitive buyer to a non-buyer is normally never an easy one.
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