Investment opportunities for 2013
Our base case scenario is that while a number of headwinds remain, economies and markets may surprise on the upside, especially in the US. In the last quarter of 2012, expectations have been so subdued, that the only way is up.
Central bankers have been explicit in their willingness to uphold economies, and we expect their coordinated responses to continue.
We do believe, however, that unless there is an 'ice age' scenario, and with the potential for debt cancellation (what we would term as QE4), and therefore subsequent inflation risk, the central banks will not be forthcoming in their implementation of more QE.
In 2013, a deflationary scenario is unlikely, but remains a risk that markets will worry about. Instead, we see sub-trend growth and a small pick-up in inflation.
Over the next three years, we see investors fretting about an inflationary environment, peppered with periods where fears of deflation take precedence.
In 2013, investors should expect a year of greater market volatility (technically, volatility in 2012 has been very low, although it has not always felt like it). All things considered, we believe the management of volatility and risk in portfolios will assume a much greater significance.
US growth is stronger, as evidenced by the upward revision of US Q3 GDP, and we expect this to continue to gain traction. We see a resolution to the US 'fiscal cliff', despite the political brinkmanship of late, as the alternative is too horrendous to contemplate. The 'cliff' may creep into 2013, but much of the news has been priced-in.
We believe a bipartisan agreement will be reached. Indeed, with company forecasts overly-pessimistic, we believe there is room for significant earnings surprise on the upside. Furthermore, the continuation of the US Federal Reserve's bond-buying programme should benefit sentiment and therefore risk assets.
Lately, investors have been too bearish, although we are also inclined to revise down our growth forecasts to 6-7% - still strong, but more akin to a normalisation of expectations.
We believe China's version of authoritarian capitalism is unsustainable in its current form; indeed, we would go so far as to say that China could become ungovernable in its current incarnation over the next 10 years, with a recent field trip revealing, (albeit anecdotally), signs of militancy in the private sector.
The Gini Coefficient, a measure of income in equality, is at its highest level since 1949. Social discontent is a real issue, and how the new regime choose to address this will be as crucial for domestic politics as it will be for international perceptions. The regime's focus on rudimentary healthcare is likely to be positive for pharmaceuticals.
Europe seems to be boring investors into submission. Indeed, the debate around Greece's debt is no longer a market-mover. Any resolution in Europe will mean a 'hair-cut' for peripheral bond-holders and Germany taking more of a financial hit.
President of the European Central Bank, Mario Draghi, has done a tremendous job with regards to talking down bond yields (at the time of writing, Portuguese and Italian 10-year yields are close to two-year lows), without any money exchanging hands.
The European 'event' next year, barring any nasty surprises, will be the German election in October. Between now and then, Chancellor Angela Merkel has an even more intricate balancing act to perform, between domestic objectives and broader European interests. If she wins, she will have time to allow her to follow less populist action and support the Union - something that will be very positive for market sentiment.
By extension, if the worst case scenario in Europe is avoided, the UK will experience a much-needed palliative (by worst case, we refer to the collapse of the Euro). Otherwise, the economy is likely to stumble along an uninspiring growth path.
We view the revised third quarter GDP figure of 1% appears as somewhat of an exception, and figures into 2013 are still vulnerable to technical anomalies.
We would like to see the Chancellor curb rising taxes, which are eroding consumer spending power, already under pressure from inflation rates, well above earnings' rises. We do expect a dislocation of the economy and stock market in the UK, with FTSE returns of around 5-6%.
Gilts have little intrinsic value these days, but they can offer protection against falling equity markets. Furthermore, low nominal spreads look very vulnerable. We favour exposure to gilts in the long duration space, which tend to have a lower correlation to equities, and thus provide us with a good diversifier.
Current spread levels do not provide a buffer from any inflation surprises, especially if governments decide to cancel debt – something which we believe there is a high possibility next year - or if issues persist in the Middle East. We would therefore look to buy into index-linked gilts.
Equities: The move from 'RoRo' to 'RaCy'
We are constructive on equities and will selectively increase our exposure. Indeed, we expect more of a dislocation between equity markets and economies, whereby market could still move higher next year, despite macro-headwinds.
Equity volatility has technically been quite low; however, this is something we expect to rise next year, which could lead to violent rotations in sectors. This will see the shift from simple RoRo (Risk-on/Risk-Off) movements to RaCy (Rapid Cycling), where cycles will be quicker and much more pronounced.
We favour US equities over the UK, and emerging markets. Most bullish on countries making up the Association of Southeast Asian Nations (ASEAN), although this is consensual amongst a number of Asian managers in which we are invested, and valuations are not cheap.
Aside from these well-publicised structural drivers of excellent demographics, growing disposable incomes and urbanisation, it has recently come to light that by 2015, this region should have agreements in place, such that people and goods can travel freely cross-border, as is the case in the European Union.
Extensive high speed rail links are being built. Despite close proximity to China, we do not view this region as a China-play, as the majority of trade is intra-regional. Our preferred strategy is emerging market income.
David Coombs is head of multi-asset investments at Rathbones Unit Trust Management
This feature first appeared on our sister website Money Observer
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
A collective investment vehicle (known in the US as a “mutual” or “pooled” fund) and similar to an Oeic and investment trust in that it manages financial securities on behalf of small investors who, by investing, pool their resources giving combined benefits of diversification and economies of scale. Investors buy “units” in the fund that have a proportional exposure to all the assets in the fund, and are bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets. Like Oeics (but unlike investment trusts) unit trusts and are “open ended” funds, meaning that the size of each fund can vary according to supply and demand of the units form investors. Unit trusts have two prices; the higher “offer” price you pay to invest and the “bid” price, which is the lower price you receive when you sell. The difference between the two prices is commonly known as the bid/offer spread.
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
This is the opposite of inflation and refers to a decrease in the price of goods, services and raw materials. Economically, deflation is bad news: the only major period of deflation happened in the 1920s and 1930s in the Great Depression. Not to be confused with disinflation, which is a slowing down in the rate of price increases. When governments raise interest rates to reduce inflation this is often (wrongly) described as deflationary but is really an attempt to introduce an element of disinflation.