The beginning of a New Year is traditionally when the Financial Crystal Ball gets dusted off in an attempt to peer into the future. Investment banks, wealth advisors, fund managers all publish their thoughts and forecasts for the year ahead. But beware these supposed soothsayers of the City. A friend and ex Goldman colleague described it thus:
“Virtually the entire financial community makes a living out of persuading the punters that they can tell the future better than the pack. When you look around for evidence that ANYONE can do this, there are only a truly tiny number of people who can point to a record that statistically demonstrates they can beat the markets. So why is it that people continue to believe the pitch? Greed, ignorance and sheer stupidity. The other problem is that people in the business get paid so much that they persuade themselves they are different. It’s like a weird combination of modern day snake oil salesman and almost total self-delusion”.
I couldn’t agree more and have written many times of the folly and futility of financial forecasting and the benefits of passive investing. The pretence that any bank, advisor, broker etc is better at picking stocks or assets than using a dartboard to pick winners was the main reason I left the industry. The omnipresent failure to forecast financial markets is also the reason I never give out precise numbers now.
But with this health warning in place, there are a number of themes that I think will be important in 2014.
The first major theme is the acceleration of the global economic recovery. Credit Suisse estimates that global growth will accelerate to 3.7% in 2014 from 2.8% in 3Q 2013. As I have written before once momentum starts to build, forecasts tend to be too low and so there is a real risk that the recovery in the developed world could actually be a lot stronger. In America, fiscal tightening hit output in 2013 taking about 1.5% off GDP. But this year, US fiscal policy is only expected to hit GDP by a much smaller 0.4%. Both America and the UK could end up expanding at 3% in 2014 – a relatively heady pace. And it’s not just in America that the fiscal drag is reducing, it is in Europe too, helping the recovery. Consensus eurozone growth is for about 1% expansion this year. One of the first casualties of the crisis, Ireland, is expected to grow at double that average, i.e. 2%, which will be one of the strongest in the currency bloc and on a par with Germany! Portugal and Spain are both expecting some increase in output and even Greece could finally have an up positive yearly GDP print. Recent equity market volatility has been at low levels suggesting increased confidence in the global recovery.
The second theme is the continued reduction in global risks, particularly with respect to the survival of the eurozone. Of course as Donald Rumsfeld so eloquently put it, “there are (also) unknown unknowns. There are things we don’t know we don’t know”. So with the exception of unforeseen eurozone disasters, I do not see the Euro crisis flaring up again. However there are a couple of things to be aware of in 2014. Firstly European Parliamentary elections are in May and the fear is a rise in nationalistic anti Euro parties. Secondly there is the election of the new President of the European Commission as Jose Manuel Barroso leaves in October, which could see EU members jostling for power. But there are two very important great anniversaries in 2014 which will remind many Europeans of the importance of working together. Firstly it is the 100 year anniversary of the start of the Frist World War in 1914 and secondly it is the 70th anniversary of the end of the Second World War. Both highlight the appalling cost of European disunity and remind us all of why the EU was set up in the first place.
So no more eurozone crisis, even if Greece still has unsustainable levels of debt, Italy has a dysfunctional political system and the ECB is taking on eurozone bank regulation in 2014. There is still much work to be done but the worst is behind us. This means that risk assets should continue to do well and safe havens less needed by investors. In the height of the crisis, the price paid for safety was extremely high. This has fallen but probably not far enough yet – Gold was clearly a loser in 2013 and the consensus is for that to continue in 2014. Buying risk is a sensible trade in a stronger economic and less risky environment. In the crisis, correlations between assets increased. With the recovery there is also likely to be more divergence of performance between countries and assets.
The next big theme is increasing rates and bond yields (which already started in 2013). The Fed began to taper last month, December, and most expect US QE to be finished by the end of 2014 with the first Fed Funds rate rise in 2015. The gradual normalisation of monetary policy has now begun. But if the US economy is stronger than expected, then markets will start to price in an earlier rate rise. In fact stronger growth in the UK and the US could leave the two central banks behind the curve, not raising rates as quickly as they should. With the potential of 3% GDP growth and central bank rates of 0.5%, both the Bank of England and the Fed could be criticised for complacency during 2014. Which leads me onto another theme: determining the Output Gap. How much damage has been done to the long term potential output of an economy from the financial crisis? How much of an economic recovery can we have without triggering inflation? These are theoretical questions to which few have answers but the answers become more and more important the further we get into the recovery. This theoretical and unmeasurable concept – the output gap – becomes very important right now because it determines how quickly inflation re appears in the recovery and therefore when rates will need to go up.
2014 will also see increasingly divergent policies pursued by the world’s developed central banks. The Fed has begun to taper and the UK’s unemployment rate is not far from the 7% where the BOE says it will begin to look at tightening. At the moment it looks like the BOE will be the first major developed world central bank to tighten, before the Federal Reserve, which is extraordinary. I don’t know if Carney is brave enough to be the first to move. At the same time the ECB is becoming more dovish, with the possibility of another rate cut, and the BOJ is expected to announce more QE soon. So for the first time since the crisis began, we have the key central banks moving in opposite directions. This will be vital to the performance of currencies and assets and is the main reason why many are forecasting a stronger Dollar and Sterling this year and the trend of a weak Yen to continue. The Key question is whether to invest in places with strong economic growth or easy monetary policy?
The inflation / deflation debate will also become more divergent. The ECB is expected to adopt more stimulus measures: possibly one more LTRO, further reduction in collateral requirements, and another rate cut. All to try and get cheaper lending to small and medium sized firms, or in their words to put right the failure of the “monetary transmission mechanism”. Wages need to fall in the troubled periphery nations to restore their competitiveness, but it creates deflation. And yet at the same time, the BOE must be worrying when stronger growth will trigger inflation (especially if workers start to demand wage rises to make up for the years of none). And of course how can an almost $3tn of Fed balance sheet not create inflation in the US? Japan of course is still fighting its deflationary battle.
I believe that equities should do well again this year. Consensus earnings growth is 11% for US companies and 17% profit growth for Europe firms. That is a solid performance and should see good price rises even without multiple expansion. Equities should take Fed tapering in their stride as long as the recovery is strong enough. Historically equities have periods of sustained outperformance and underperformance that can last decades. The last few years could be just the start of a strong bull market. Remember the FTSE100 is still not back to the level it reached in Dec 1999.
Of course one of the easiest ways to pick potential winners and losers in a year is to assume anything that did badly last year will do well this year. On that basis, the recommendation would be to go long Gold, Yen and bonds and short equities. In fact there is a consensus of opinion that Gold, Bonds and Yen all should have a bad 2014, and I always like to go against consensus. As the market is very short Yen, there is a potential for some sharp upward moves if the US economy disappoints. But although I like to be a contrarian, there are solid reasons why Gold (safe haven not needed) Yen (aggressive BOJ and Abenomics) and bonds (rising US rates) won’t have a great 2014.
Using the same “pick the losers’” technique, commodities are predicted to have a good year in 2014, after falling prices in 2013. According to Bloomberg surveys corn may be highest riser with prices predicted up 20%, platinum up 23% and nickel up 19%. For the first time in the recovery there is positive and increasing growth in the US, Europe Japan and the emerging world. And US CFTC data shows that many are betting on commodities in 2014, with net longs of futures and options contracts for 18 commodities up four consecutive weeks.
Also after a poor 2013, the emerging world may have a better 2014 thanks to the global economic recovery. According to Bloomberg the consensus of opinion is for modest strength from Asian tiger currencies and Asian emerging economies are expected to grow 6.5% in 2014, according to IMF forecasts in Oct. And one month implied volatility in forex options also suggests more confidence in Asia, as it fell in past 6months for all except one of the region’s 11 most used currencies.
The main risk to all this optimism is China and again there is a consensus that this economic superpower could upset the rosy picture thanks to its housing, credit and investment bubbles. The consensus is for around 7.5% growth in 2014. But it’s all about reform – in November Chinese leaders promised to accelerate interest rate and foreign exchange reforms. It all remains to be seen whether the walk matches the talk.
After all you only live once…Global recovery now firmly in place, rates in the US and UK beginning to normalise and scary eurozone days gone. 2014 may be the year to embrace a little risk.
(or twice if you’re James Bond):
