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Expect the Unexpected

12 May 2014 Tristan Hanson, Ashburton Investments
Tristan Hanson, Head of Global Asset Allocation, Ashburton Investments.

Tristan Hanson, Head of Global Asset Allocation, Ashburton Investments.

The first few months of 2014 have proved to be fairly challenging for most investors. Entering the year, there was an almost universally held set of consensus views: equities would perform well, bonds would suffer as yields rose and the US dollar would strengthen (against the yen and euro in particular) as the Federal Reserve pared back Quantitative Easing (QE). Most economists were optimistic about US prospects, expecting accelerating growth.

But there will always be surprises. The unforeseen escalation of events in the Ukraine as well as the prolonged bout of severe winter weather in the US reminds us of this. Such events have contributed to the ‘surprising’ outcomes in markets so far this year: equities have underperformed government bonds, the US dollar has been lacklustre and US growth has been weaker than expected. Other important factors have been less unexpected but have weighed on markets, including growing concerns around China’s economy and fragilities in several emerging market countries.
 
The upshot of these events has been to shake confidence among market participants and the previously tight range of views has widened.

So where does Ashburton stand in relation to the market outlook for the remainder of 2014?
We continue to believe that the global economy will accelerate this year from the sluggish performance of 2013. This will be led primarily by stronger growth in the euro area and the US, which together make up 40% of world spending. Recent data suggests the euro area economic recovery is on track. The US outlook has been questioned by recent data, but we believe this has been overwhelmingly a weather-related slowdown. As the winter thaws, we expect stronger data. The February pick up in manufacturing and recently stronger loans growth are encouraging.
 
Emerging markets face a more challenging backdrop than for some time, although overall growth should still surpass developed markets. Much has been made of the so-called "Fragile 5” (Brazil, India, Indonesia, South Africa and Turkey), that have been forced to raise interest rates in response to currency pressures and inflation concerns. But it is China that will determine the overall outlook for emerging markets and the global economy. While we are aware of the downside risks, our central view remains that China can achieve growth in the region of 7%-7.5% this year and avoid a financial crisis.

If our central economic views are correct, we expect the Federal Reserve to continue reducing the pace of QE purchases, ultimately winding up the programme in the fourth quarter this year. Attention will increasingly turn to the timing of interest rate hikes both in the US and UK. Our central view is that rates will start to rise in Q1 2015 in the UK and Q2 2015 in the US. By contrast, we think the Bank of Japan and the European Central Bank will further ease policy.

With inflation low across the industrialised world and investors likely to worry about the implications of a ‘post-QE’ world, we expect the Federal Reserve to proceed with monetary tightening relatively cautiously.
 
We expect government bond yields to rise gradually in this environment, suggesting minimal returns for the asset class. As such, recent underperformance of equities versus bonds is likely to reverse and equities will remain the asset class of choice, benefiting from stronger revenue and earnings growth. Valuations have become less attractive as the equity market has risen strongly over the past two years, but not prohibitively so on a global basis.

Of course we must always be attuned to potential risks.

Presently, developments in China are our most significant concern given the growing spate of financial sector problems. While on a slower path, we believe the authorities have room to stimulate the economy should growth deteriorate further.

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