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Equities remain attractive in 2014

31 December 2013, COLUMN

2013 was an eventful year for investors – and one in which attractive returns proved to be a distinct possibility. Whether investors can expect the same from 2014 depends as ever on what the fundamental developments are. Will the recovery currently underway continue, or do investors need to worry about a sharp correction? Wealtheon anticipates that 2014 will see enough of an economic recovery for equity markets to continue rising.

United States

The world’s largest economy - the USA - showed a clear recovery in 2013 and Wealtheon expects this trend to continue in the coming year. Many of the (leading) indicators that we track on a daily basis are showing a positive trend. The housing market is recovering, employment is on the up and, on balance, confidence is growing steadily among both producers and consumers. This will allow consumption to increase gradually. The ISM manufacturing index is at its highest since April 2011. The same scenario applies to the Chicago PMI (Purchasing Managers Index). Both long-term and short-term interest rates will remain low, at least in historical terms.

Having said that, we are certain that long-term interest rates will rise in the USA. The Fed has stated clearly enough that it cannot continue to stimulate the economy forever. However, even if long-term interest rates rise towards the 4% mark, we believe that the American economy will be able to absorb this increase without losing too much momentum. As happened in June 2013, a reaction to rising interest rates can be expected on the housing market, but this will be a relatively short-term affair because improving confidence (based on the recovering economy) will continue to be the determining factor.

Euro zone

The outlook for 2014 in the euro zone remains very mixed. Euro member countries to the north of France are managing to create a little breathing space, driven mainly by exports. We also expect domestic consumption in the euro zone to increase gradually, stimulating further economic recovery. The situation in southern Europe remains a matter of concern for the time being, but we do not expect the situation there to worsen any further. Since structural reforms require time to take effect, it will be longer still before they have any visible impact. In fact, we anticipate that we will not see any structural improvements until 2015. However, the equity markets may anticipate this and factor it in early.

Emerging markets

For Latin America and Asia, we reiterate that countries with a strong export position will be the most attractive for equity investors. China, which is now depending increasingly on domestic consumption, remains an interesting prospect for the medium-to-long term in view of the structural measures being taken by its government. India and Argentina are currently experiencing very high inflation, as well as high interest rates, so for the moment we are keeping them on the substitutes’ bench.

Bonds - risk or opportunity?

2014 will once again be a challenging year for bond investors. Rising interest rates during the year, which we anticipate, mean that bond rates will continue to fall. We have taken these rising rates into account when composing our bond portfolio. Unlike many asset managers, we have not (!) fled towards bonds with lower credit ratings (below BBB-). Our philosophy is that the quest for returns should never be at the expense of risk management. Bonds with a credit rating below BBB- today are described as 'high-yield', whereas previously they were known as 'junk bonds'... This type of bond dropped sharply in value after the economic crisis was triggered in 2008 and it took investors many years to recover from their losses. Fortunately, as a result of our prudent risk management philosophy, we were not harmed by this disastrous development, making it a lesson not to be forgotten.

Although the rising interest rate environment will lead to low - potentially negative - returns, there are in fact plenty of ways to benefit from this trend. We strongly recommend including these alternatives as part of a fixed-income portfolio.

Equity market correction?

The big question remains as to whether or not investors should anticipate a general correction in the markets. Given the speed with which the markets rose in 2013, a correction of 5% or even as much as 10% is quite likely to occur.

As always, we don’t know what will trigger a market correction of this kind. We are operating on the assumption that the reason for any correction will purely be profit-taking, for example following the announcement of poor interim economic numbers. In other words, it will not be because investors are losing faith in the longer-term global economic recovery. For the moment, we still believe that the economic recovery will be a lasting one and in the days following a correction, investors will as ever determine their strategy based on the actual underlying developments. But backed by the continuing economic recovery, the equity markets will be able to recover quickly from any correction, because nobody will want to miss the price-gain boat as markets resume their upward trend.

As long as returns on equities are higher than yields on savings accounts or bonds, equities will continue to be fundamentally attractive. And in 2014, this will certainly be the case.


Macroeconomics


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