In 1987, British weather forecaster Michael Fish gained notoriety on the eve of what was to become one of the largest storms ever to hit the UK when he opened his bulletin by saying, "Earlier on today, apparently, a woman rang the BBC and said she heard there was a hurricane on the way... well, if you're watching, don't worry, there isn't."
It wasn't quite career suicide for this weather forecaster as 100mph winds lashed the country that very evening, but it was certainly a lesson in being emphatic in the face of uncertainty.
And there is certainly an overwhelming temptation when looking forward to a new calendar year and making predictions about equity markets to avoid the emphatic.
Furthermore, the very nature of looking forward to a new year as we leave an old one behind implicitly suggests (and tempts forecasters to predict) that what lies ahead will be different from what we are leaving behind.
For equity investors in 2014, this may not be the case: we are currently in the midst of a synchronised global economic expansion, albeit a rather tepid one, and in our opinion all the evidence suggests this is likely to continue.
With a little more quantitative easing (QE) to come in 2014, we can likely expect equity markets to go higher…as long as the storm clouds are kept at bay.
A tumultuous year
Much has changed over the last year. While 12 months ago there were already signs of a US housing market recovery, signalling an end to the US economic slowdown, investors were worrying about the ‘fiscal cliff’ and debt ceiling pressures derailing the recovery.
Forced reductions in government expenditure have certainly impacted growth rates but on balance, the US economic recovery is increasingly broad-based.
All of which explains abounding talk of the Federal Reserve ending its extraordinary measures of economic support – because the economy is in better shape it can cope without unconventional measures of assistance.
On the other side of the world, in Japan, while in December 2012 Shinzo Abe had just returned to power, investors were not then fluent in the lexicon of 'Abenomics' and his government's aggressive determination to stimulate the economy via the ‘three arrows’ of fiscal stimulus, monetary expansion and structural reform.
Throughout the year, there has been some evidence that the first two of these arrows are starting to have an impact on the economy, although the jury seems to be out on the third arrow. Still, this is progress and Japanese GDP expanded in each quarter of 2013.
In the UK at the end of 2012, the popular press was speculating about a ‘triple dip’ recession despite increasing evidence of government lending stimulus starting to impact the economy.
However, there was no talk then, as there is now, of an emerging housing bubble. A recovering housing market has been key to the return of consumer confidence and the UK economy is now growing at a rate of around 1.5 per cent. In Europe last [northern] summer, European Central Bank (ECB) chief Mario Draghi's promise to do "whatever it takes" to prop up the peripheral bond markets helped the eurozone turn the corner.
2013 became the year when conditions moved decisively from ongoing economic deterioration to, at the very least, becoming ‘less worse’; in many eurozone countries, there is actually emerging evidence of growth.
Pulling in the right direction
All this, therefore, has led to a state of global synchronised economic recovery in the developed world. It may be tepid in nature and as such, vulnerable to any unexpectedly stormy weather but equally, from such a low level, there must also be the potential for positive momentum to build into 2014.
The more controversial aspect of the global debate is dominated by emerging markets (EM) and the question of what their contribution to growth will be in 2014. In broadest terms, while growth from the developed world is accelerating from a low base, growth in EM this year has been decelerating but from its very high base.
There are many nuances and of course country-specifics that we need to be aware of, but in broadest terms, concerns largely relate to ballooning current account deficits, such as in Indonesia, Turkey, South Africa and India.
These look likely to be exacerbated as bond yields and perhaps ultimately interest rates rise in the United States, which in turn will force protective central banks to raise domestic interest rates (to attract capital flow to shore up the holes in their budgets).
This will likely have nasty implications for credit, which in many cases has been generously available because money has been so cheap. We would suggest that the ramifications will be felt in the coming year.
The trigger for the turnaround of EM as an asset class, moving from hero to hated, was Fed chairman Ben Bernanke’s announcement in [the northern] spring of 2013 that the US central bank would soon be looking to ‘taper’ its bond purchases.
Less QE and lower levels of monetary liquidity were initially seen as a bad thing by investors – certainly for EM, for the reasons noted above – yet beyond their summer wobble, markets have continued their steady ascent. Bond purchase tapering speculation has been rife over ‘what’, ‘when’ and ‘how’.
QE tapering off
Regardless of the details, key in our mind is that bond purchases are going to stop because the US economy is in better health: it doesn't need this additional support. This is actually good news no matter how it’s dressed up.
But even when the Fed’s ‘tapering’ takes hold, for those that believe that US QE alone has driven markets higher this last year, there is always the Bank of Japan (BoJ).
By our reckoning, if US central bank bond purchases taper down from current levels in the spring of 2014 to zero by the autumn of next year, the size and scale of bond purchases promised by the BoJ in 2014 will leave global central bank balance sheets 13 per cent larger in a year's time. So more support for equity markets in 2014?
But what of the risk of hurricane winds? In lowering interest rates recently, the ECB warned of the risk of deflation across the eurozone. In the USA, if the largest bond-buying program ever seen has been unable to stimulate sustainable inflation (core CPI is just 1.2 per cent) then what happens when it goes away?
In Japan, in case we need reminding, everything that Prime Minister Abe is trying to do is focused on ending the spiral of deflation that has dogged the country for two decades. It will remain a constant threat given the lukewarm nature of the global recovery. This is the storm cloud on the horizon – the nagging doubt for investors in 2014.
2013 was very much about global synchronised QE and equity markets rising in anticipation of a return to growth in corporate profitability.
2014 will likely be the year of diminishing support for global economies as they continue their (tepid) synchronised recovery. For equity markets to rise meaningfully, however, we would argue that the expectation of growth in corporate profits needs to become a reality.
Profit margins are at all-time highs in the USA, but there is room for a meaningful recovery in Europe and Japan. It would be our expectation that after five years of aggressive cost-cutting in Europe – and longer in Japan – that any top-line recovery leverages into some more impressive bottom-line growth.
This could positively surprise not just investors, but in some cases management teams too, given their much-needed aggressive focus on costs during recent tough economic times. However, with valuations having already increased in anticipation of this, any disappointments here mean negative consequences.
Forecasting the weather more than 48 hours ahead is challenging. From what we see, however, largely informed by the hundreds of company management meetings that we conduct globally, we think the weather is set fair.
We are in the midst of a tepid synchronised global economy recovery. There are those who are warning there is a storm called deflation coming our way. But for now, don't worry, there isn’t...
Matthew Beesley is the head of global equities at Henderson Global Investors.
