In the beginning of every New Year, it is traditional to look back on the events of the past year and then look forward to the coming year.
The Politics: Following years of the euro-zone debt crisis, with all the accompanying political turmoil and instability in many countries, one of the most obvious conclusions, to begin with, is that from a political perspective, 2013 has been a year of relative quiet and stability. It is positive to note that Italy still has a functioning governing coalition, while the long-drawn-out German election result of a new grand coalition, recently finalized, ushers in “more of the same” for Germany and Europe. Looking overseas, the US kicked the budget and debt ceiling through into 2014 without fixing anything whilst Japan and the UK saw improving economic conditions as central-bank policy was transfused into getting the cash into the veins of the real economy rather than the varicose ones of the banks solely.
The Economics: The European economy has improved compared to 2011 and 2012, but has failed to deliver significantly stronger growth, against a background of a global economy which has, for the most part, been dull this year. The US, whilst making progress, has nevertheless struggled to hit escape velocity, while China has started to transition more positively under the new leadership in a direction which could be referred to as moving from “made in China” to “made for China”. For emerging markets it was a tougher year, with many battered by the US Federal Reserve (Fed) comments on tapering last spring such that their economies experienced rising rates and slowing prospects into the second half of the year.
The Markets: In performance terms, the star equity market this year has been Japan, with a rise of over 50 per cent in yen terms, closely followed by the S&P 500 Index with a rise of over 25 per cent. Europe has seen gains of over 15 per cent whilst most of the BRICS nations (Brazil, Russia, India, China and South Africa) and emerging markets are flat to down. Commodities have all seen sharply falling prices with gold down more than 30 per cent over quantitative easing (QE) fears.
The Currencies: Currencies have seen a year of euro strength and Japanese yen weakness. Sovereign bonds have seen negligible or negative returns whilst the European peripheries have done well; so have high-yield bonds, which have achieved returns of over 10 per cent.
So with the AllianzGI view – that we are in a period of global financial repression – 2013 is a year in which it has paid to take risk as we advised and also a year where corporates started to feel the repressive behaviour of governments over tax avoidance, threatened price controls and changes to existing regulation.
Tapering and slow recovery in 2014
I look into 2014 certain that we remain challenged by the world of financial repression where interest rates will remain low and policy eased even more through negative deposit rates, where savers will suffer from negative real yields and where governments will continue to tax their way to success rather than restructure their over-leveraged debt-fat economies and lifestyles. So it will remain tough in the real world.
For investors, the opportunity set seems clear to us: Take more risk, and whether it is to make money or to protect wealth and purchasing power, investors will look to real assets, and equities in particular, to achieve this; perhaps creating the conditions for the famed Great Rotation.
Fixed-income assets and cash will probably remain terribly repressed and, in Europe, the threat of being “bailed in” will grow as the European Central Bank (ECB) performs its Asset Quality Review. Sovereigns will continue to ensure that banks support them, thereby continuing the credit squeeze in the real economy, causing weak employment and investment levels to continue.
Restructuring will be the key to success economically, and we see Japan, Greece and Italy as key candidates to head in this direction from a defensive perspective whilst we expect China, Mexico and Russia to possibly move more positively as the year proceeds. History shows that emerging economies prosper most when fundamental and not mercantile changes occur.
Economically, the recent downgrades for world growth by the International Monetary Fund and Organisation for Economic Co-operation and Developmentseem to capture the mood as Europe struggles with recession and the world faces a tapering event, which will seem like a replay of the market events of Q2 2013 – i.e., the cost of money to many weaker industries and economies will rise again, hurting demand, investment and trade. The yen devaluation of nearly 30 per cent will export deflationary pressures to Asia, in particular, and force greater competitiveness on Taiwan and South Korea. With the cost of money being kept artificially low by central banks, we expect mergers and acquisitions in many equity markets to grow as it is now definitively cheaper to “buy rather than build” across most industries.
Sectors to watch in 2014
In terms of sectors, we see tremendous value in the unloved oil majors where disappointing production growth and rising capital expenditure costs have squeezed cash flows but where investors are encouraging managers to follow the mining sector and cut investment to boost shareholder returns – good for investors now, but this will lead to higher commodity prices in the future. Shale oil and gas continue to prosper in the US and may soon go global, maybe even into Russia. Utilities, telecoms and other industries close to governments may find themselves caught in a political vortex where the electorate want stable or lower prices whilst policy has caused rising prices, like the climate change levies as an example. Within consumers, we expect to see strong demand for some conspicuous consumption of luxury goods, as the world's middle classes will grow by over 1 billion in the next 20 years but auto volumes may peak as emission and fuel taxes crimp on demand, even in emerging markets. Media and advertising agencies look well placed to enjoy both the “old wave” of technology, media and telecomm convergences whilst adding the “new wave” of social media and apps. As we all experience the “ageing” of many economies over the next two decades and a dramatic slowdown in the rate of growth of the world population, so we expect to see many healthcare and pharmaceutical sectors do well, supplying both the needed care of the old but also benefitting from the emergence of new amazing technologies and tools to cure disease. Banks and many other financials, however, will remain under the spotlight of regulators and politicians so that the global financial crisis of 2008 can never happen again and leverage ratios will become ever more onerous. As mentioned, the credit crunch for the real world will lessen the enthusiasm for investment, thereby hurting many industrials whilst also promoting energy efficiency like LED lighting and pollution controls for China and other economies.
While Europe may remain relatively quiet in political terms in 2014, overall politics will still be a key weather vane for investors and retain its capacity to surprise, with several important elections to come in India, Brazil and then later in the US. Central bankers and even the new crew at the Fed, where over half the board will change in 2014, will stay on track and in tune, believing that QE is the best route to boost economic activity, thereby printing money and monetizing sovereign deficits until inflation emerges.
Investors will remain caught in the same rigged game of the last couple of years searching for returns, income and some certainty of safety from government policy, taxation and inflation. We believe equities remain living economic organisms with powers of monetary adoption, offering growth opportunities and attractive growing dividends. Europe is home to some of the strongest and most successful corporates in the world and we believe European equities continue to offer investors, in valuation terms, attractive long-term, inflation-beating returns with dividends boosting overall returns.