Market Commentary 2014 - Quarter 4 February 2015

Market Commentary 2014 - Quarter 4

The returns from equity markets over 2014 have been less momentum led than in 2013 and have shown the need for companies to deliver profits to reflect their market valuations. The continued surprise has been the resilience of bond markets and the fall in yields much against investment consensus for 2014. Western developed markets have seen strengthening economic growth, particularly in the US and UK, whilst Europe has continued to falter but on a very country specific basis.

In a normal economic cycle, investors could expect better returns from equities going forward as markets would not have run so far, or re-rated so significantly from their 2009 lows. One of the consequences of unconventional monetary policies has been that markets have front run the improvement in the global economy. At best, outside of the US, markets are fair value.

The more recent economic growth patterns have seen divergent economic recoveries and divergent expectations on monetary policy and so volatility has increased. Investors should not expect a change to these more recent patterns in 2015. In the US, although the labour market is buoyant, wage growth has remained muted, although starting to pick up in recent months. Overall the economic recovery looks set to continue which should allow the market to navigate its way through a path of moderately higher interest rates. Monetary tightening is likely to lead to some form of US market de-rating so progress is likely to lag the increase in company profitability.

Any sign of a sustainable pick up in Europe and Japan could see a positive response from their stock markets. In these economies monetary conditions, a weaker currency and lower oil prices all give the possibility of a positive surprise next year. The Chinese economy, although slowing, has seen the authorities move to deal with problems in both property and shadow banking. Confidence that a hard landing in China will be avoided would be a positive for all Asian markets next year.

Fixed interest markets have been one of the positive surprises for investors in 2014. Interest rate rises in both the US and UK have been put off, whilst markets have now factored in lower rates in both Europe and Japan. 2015 could be more challenging for government bond markets, although the fragility of the recovery and aftermath of the global financial crisis, means rates will stay much lower than peaks of previous cycles.

Globally, there is still too much debt, especially in the West, and deficient demand. Investors continue to place considerable faith in the ability of Central Banks to manage the global economy out of this situation and put the world onto a footing for sustainable growth.

Investors need to be aware of potential risks, as well as potential returns, when positioning portfolios and so portfolio diversification with some hedges against adverse outcomes is advisable. Investors should not be concerned that these hedges do not all work at the same time, the point is that they protect the portfolio against different outcomes – without them the portfolio would only do well if the central outcome came to fruition. Whilst this remains the base case, it is not an absolutely certain one. To hedge against adverse outcomes investors should consider holding some cash for short term opportunities (optionality), retain exposure to selected fixed interest markets, and look to include some absolute return funds that have delivered positive returns in years when markets have delivered a negative outcome. Investors will also need to consider what they care most about, losing money or missing out on an opportunity.

Market commentary provided by Rayner Spencer Mills – Quarter 4 2014

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