But periods of less than brilliant market performance are to be expected, and there are still reasons to believe that investors should retain an overweight to equities, despite the bumpy first quarter.
Overall economic instability made for a shaky first quarter for investors. A focus on the potential for deflation in Europe, questions about the ability of Japanese prime minister Shinzo Abe to reignite his nation’s economy, and the weather-plagued US economy all contributed to mixed returns.
Meanwhile, in emerging markets there was a general concern about the slowdown in credit growth in China and the potential for a sharp rise in defaults in wealth products (which I do not think will materialise). On the political side, there was increasing social unrest in Brazil, Venezuela and Thailand, as well as rising geopolitical tension in Turkey and Ukraine. The crisis in Ukraine has generated a lot of media attention and worry about the impact on financial markets. The direct impact is likely to be marginal given the size of Ukraine’s economy and stock market. Even the Russian Micex index has regained some of its lost ground.
It is nothing new for financial markets to suffer through short-term bouts of economic or political pain, and such periods of disruption will continue to be a feature of this year. These periods may feel very painful for investors, and drops in the market may cause some to question whether they want to remain invested or take their profits and run. The real danger is that these temporary market falls cause investors to pull out their money and miss out on subsequent rallies – and potential buying opportunities.
But there are many reasons to continue to favour risk assets. Globally, the inflation outlook is relatively benign, while economic momentum is improving in the developed word and monetary policy remains very accommodative.
European economic data continues to confirm the ongoing recovery, and manufacturing PMIs show that the region’s largest economies – France, German, Italy and Spain – are all in expansionary territory. Consumer confidence surged in February, suggesting the spectre of deflation has yet to scare consumers into a Japanese-style deflationary spiral.
At present, growth in Eurozone looks more likely to surprise on the upside than the down, despite the risks of low inflation.
In the US, the unusually severe winter weather has weighed on economic growth but not derailed the recovery, and a spring thaw may be on the way. The cold weather merely postponed demand in the economy, and after a slow first quarter, growth is set to pick up.
Job growth has been muted, but wages are rising and average earnings for production workers were up 2.5 per cent year on year at the end of February, the fastest in three years. Higher wages and growing employment will support consumer demand. Moreover, companies will soon begin to spend some of their hoarded cash and this should support earnings and equity markets.
The Fed, the Bank of England and the ECB have all taken steps to force down both short- and long-term interest rates, which has made traditional bond investments look relatively unattractive compared to equities. Even as the Fed tapers its bond-purchase programme, and expectations of the first rate hikes by the BoE and the Fed are brought forward, there is little chance of higher rates this year, and investors should lean towards equities – especially as economies get back on track after a tough winter.
However, the better performance of safe-haven assets in the first quarter highlights there are still risks to the global economic recovery. This is perhaps a timely reminder to investors to ensure their portfolios are properly diversified as they prepare to traverse the bumpier investment landscape ahead.
But these risks should not be enough to derail the economic momentum. While 2014 will not be a repeat of 2013, developed equity markets are likely to outperform fixed income, even after the shaky start to the year.
Kerry Craig is global market strategist of JP Morgan Asset Management
