Market optimism prevails but just how confident should investors be? Simon Webber, lead portfolio manager for global and international equities at Schroders, shares his thoughts.
This year has scope to be another good one for global equities. What’s more, as the dominance of macroeconomic factors on equities recedes, market leadership should begin to transition towards companies able to thrive in a more normal economic and monetary policy environment.
Having retreated since 2010, global growth in 2014 should accelerate, with full-year global GDP growth likely to be in the region of 2.9% (see figure 1). We expect this improvement to be driven by Western economies, with Europe and the US both growing faster than in 2013.
A year for stock pickers
This year will be good for stock pickers. Since the 2008 crash, financial markets have been buffeted by macroeconomic events, be it the 2008 financial crisis, the eurozone sovereign debt crisis or unprecedented money printing by central banks.
Global equities: What’s in store for 2014?
However, as the growth and policy environment begins to normalise, markets will naturally lengthen their investment horizon and should, therefore, increasingly focus on companies’ long-term growth prospects.
Confidence to invest
Despite the improvement in economic conditions this year, consumer and corporate confidence has been slow to adjust. Companies have been reluctant to invest, as shown in figure 2, which illustrates that fixed capital formation – a measure of investment – remains below average in both the US and the eurozone. This is despite the fact that large company balance sheets are generally still very healthy (because of the still largely cautious corporate mindset).
However, we are now seeing signs that confidence is returning. This is highlighted in figures 3 and 4 which show, respectively, US consumer confidence and German business sentiment. We, therefore, expect that, as confidence continues to recover next year, companies will step up investment. This will be particularly good for industrial cyclicals and capital goods industries, while giving further momentum to the economic recovery.
Positioning for higher rates
After years of loose monetary policy across the globe, markets in 2014 will have to wrestle with the timing and implications of interest rate rises. The vast amount of money being pumped into the global economy via quantitative easing (QE) programmes has given many indebted companies an easy ride and, among other things, propped up real estate markets around the world.
Furthermore, depressed bond yields have forced income-focused investors to search for income in higher-yielding parts of the equity market. This has pushed up the valuation of higher-yielding stocks as investors have searched for bond-like returns from stocks with minimal equity risk.
This has left companies with prospects for strong future earnings and dividend growth looking exceptionally good value relative to income stocks. This is illustrated in figure 5, which shows the relative value of the top 20% of high dividend yield stocks relative to the top 20% of stocks with high dividend growth.
The low interest rate environment has, therefore, distorted equity markets in recent years. Investors should now look for companies that can thrive in a rate-normalising environment. There will be opportunities across almost all sectors.
Examples include banks with very strong deposit franchises and life insurance companies which will earn better returns on their investment portfolios. Individual companies with strong brand and pricing power should also perform well, as should later-cycle cyclical sectors, such as capital goods.
Global competitiveness is shifting
One country which will likely buck the trend of a rising rate environment, however, is Japan, which is positively encouraging a more inflationary environment. If the current policies are not successful, its central bank will likely step up its QE efforts further.
This should continue to be good for Japanese exporting companies; however, any further weakness in the yen will affect the competitiveness of companies competing on a global stage. German, Korean and Taiwanese exporters are likely to feel some pressure, and this is something we are monitoring carefully across our investment portfolios.
When the tide goes out
Ultimately, throughout 2014, we will be moving to the next phase of the economic cycle. Momentum in early cyclical stocks will inevitably move to later-cycle areas of the market. Complacency in the market about the low interest rate environment will open up opportunities for astute investors.
To paraphrase Warren Buffet: when the tide goes out, we will see which companies – and perhaps which investors – have been skinny dipping.
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From 6 April 2019