As we approach the end of 2014, we thought we should take the time to reflect on the last year and look ahead at what’s to come in the next 12 months. In this article, three of our in-house experts share their thoughts:
Peter Michaelis, Head of Equities
Rod Davidson, Head of Fixed Income
Linsey Congdon, Economic Research Analyst
Peter Michaelis, Head of Equities
Economically 2014 was a year when many anticipated events just failed to happen. We expected: an EU recovery; interest rate rises in the US; US and UK bond yields to rise (ending a 30 year downward trend); economic growth to become self-sustaining and equities to outperform corporate bonds by a fat margin. Instead we got an EU economy in need of further stimulus; US interest rates held at 0.25%; yields falling to new lows (2.1% on US 10 year in October); weak global growth and corporate bonds returning more than equities again. Then there was massive QE in Japan and stimulus in China. The final unpredicted surprise was the dramatic sell off in commodities and oil from August.
In equity markets the first quarter carried on from the trends in 2013 with growth outperforming, favouring our focus on high quality companies. However April saw a marked change in leadership with the high yield, defensive companies to the fore. This was a challenging environment for our style of investing, but one we resolved to ride out. The final quarter has vindicated this approach as equity markets recovered from their October trough with high quality growth companies leading the way.
So although events did not turn out as we predicted, our long-term approach which focuses on high quality, sustainable and predictable companies stood our portfolios in good stead. Indeed in an uncertain world it is, to my mind, the only sensible approach to take.
We have also been active in promoting more responsible business practices in companies. Engaging with UK banks to identify those that have improved sufficiently for us to invest (we remain broadly unconvinced that many have changed enough); and continuing to work with high street retailers on sourcing from Bangladesh in a way that respects human rights and builds long-term partnerships. On the latter, we welcome the number of retailers that have signed the Accord, but are shocked that not one factory supplying this enlightened group passed the first inspection.
Also in 2014 we saw the creation of a single equity investment team at Alliance Trust to manage both the Sustainable Future funds and the Alliance Trust global equities portfolio. It is a fantastic endorsement of our investment approach that a company with such a long pedigree in investing (126 years) has decided that the future lies with sustainable investing.
So what will 2015 bring? We predict more uncertainty! But also a backdrop of improving but sluggish economic growth. Yes, even in Europe. Government bond yields will start to rise; and equities should outperform corporate bonds. All of which sounds similar to what we said last year. Perhaps like the broken watch we will be correct this time!
Rod Davidson, Head of Fixed Income
2014 proved to be another year in the post financial crisis era when the recovery failed to take off and we end the year seemingly no nearer a normalisation in the interest rate cycle as inflation struggles to remain in positive territory. In a year that we take time to remember the 100th anniversary of the beginning of the Great War and all those that lost their lives, conflict still makes the headlines with Ukraine imploding, NATO might be pulling out of Afghanistan but ISIS has taken up the Muslim extremist fight in the Middle East and the situation there is far from stable. Central banks remain forever in the headlines as economies struggle to move forward and 2014 saw Japan and Europe introduce significant QE programmes and the US end their third round. Cheap money remains the order of the day and government bond yields around the world continue the race to the bottom. OPEC, which for years has set the pace for the oil price seems to have lost the dominant hand in 2014 and the price has fallen significantly during the course of the year.
Looking specifically at the UK, the macro backdrop can be summarised as being ok and considerably better than all its European counterparts. There is no room for complacency however, with only a limited improvement in the dire budget deficit situation and a troublesome general election looming for May 2015. Employment conditions have improved but as yet there is no sign of potential wage pressures and as a result confidence remains subdued which is detracting high street sales patterns. The good news is that mortgage rates have fallen during the course of the year, but most analysts are now predicting a rise in interest rates at the end of 2015, so economic activity may be nervous ahead of this possibility.
It remains a tough environment for bond investing, but this is largely to be expected given that we are coming off the back of a 20 year rally which has seen 10 year gilt yields fall from around 12% at the beginning of the 90’s to around 2% today. With the 10 year bond yield sitting comfortably below 1%, one could argue that gilt yields may have further to fall, yet we strongly believe that the end game is drawing closer and investors should consider their exposure to bonds and make sure that the funds that they own have sufficient flexibility within their mandates to appropriately manage them during a rising rate environment.
Linsey Congdon, Economic Research Analyst
In the US, forecasts for both growth and inflation have softened throughout the year. Part of the reason for this is the failure of corporate spending to materialise, despite strong balance sheets. The oil price will be a key indicator in 2015 and in particular the effect it has on the consumer who has continued to suffer a lack of higher real wage growth. Despite the unemployment rate falling, many of the jobs created have been part time which has resulted in lower than desired wage growth. But despite all of this, GDP growth is on track to be 2.25-2.5% this year. This has allowed the Fed to successfully taper its quantitative easing programme and current expectations are for the first interest rate hike to come in the second half of 2015.
Chinese economic growth looks set to continue to slow towards, or just below the level of, 7% and it looks likely that the authorities will cut their growth target from 7.5% to 7.0%. The largest risk in both 2014 and going forward is the housing market.
However, the recent interest rate cut, together with liquidity injections and removal of housing market restrictions, have helped to stabilise demand and construction activity.
In Japan, economic growth has been weak following the April consumption tax hike and this has resulted in the next hike, from 8% to 10%, being postponed from October 2015 to April 2017. At the same time, Prime Minister Abe has called a snap election, to be held in mid-December in an attempt to regain enthusiasm for his reflationary policy of ‘Abenomics’. Due to worries about not meeting the new, higher inflation target, the Bank of Japan recently took the decision to expand quantitative easing, further increases of which look possible next year.
One key challenge for Europe has been events in Ukraine and Russia, which have undermined confidence and activity. Although some sanctions against Russia have been put in place, the problem could continue to challenge European activity in 2015. The ECB has been signalling that quantitative easing, via the purchase of sovereign bonds, could be on the way. If this is the case it is likely to be delivered early in 2015. A key concern for the region, as we move into 2015, is the broad level of low inflation.
After several years of sluggish performance, the UK is on track to record the strongest level of growth of all the major economies this year. But the outlook for 2015 looks much more challenging as fiscal consolidation increases, uncertainty surrounding the May election approaches and a lack of demand from the Euro area remains. The General election is a critical event as it has implications for fiscal policy and in turn, the value of Sterling, monetary policy and whether a referendum on Europe will be held at a later date.
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