For the first time in 20 years, all major asset classes delivered a positive return in the first six months of the year.
Given the performance of equities in 2013, however, it should come as no surprise that so far this year returns have been lower, not least thanks to a generally weaker than anticipated economic recovery, and the ongoing tapering of quantitative easing (QE) in the US.
Central bank support has remained a key market driver, with continued aggressive QE in Japan, measures taken by the European Central Bank to counter deflation, and continued monetary accommodation by the Bank of England, in spite of UK growth expected to be more than 3 per cent for 2014 as a whole.
Throughout the period, volatility remained low across equities, fixed income and currencies, with no significant drawdowns in major markets.
Some commentators suggest this points to worrying complacency, but equity markets appear to be enjoying a sweet spot, with reasonable earnings and improving economic data, and most importantly, supportive central banks appear in no hurry to tighten monetary policy.
We remain broadly positive on the economics but a little more cautious on markets. While absolute market levels have generally moved higher, it is worth noting the significant rotation out of small caps into large caps and from growth into value, which then reversed to an extent towards the end of the second quarter.
The Vix, the so-called fear index of volatility, touched a post-crisis low during June, and it does appear that markets are continuing to ride the wave of liquidity and support provided by the central banks. However, investor complacency is a potential concern, as when this liquidity theme ends, investors will need to consider how strong fundamentals really are.
We don’t dispute the strength and recovery of certain economies, but do feel this is already priced in.
In spite of being slightly underweight equities, we continue to find little value in fixed income and continue to use both FTSE futures and alternatives funds to provide protection and diversification.
We have gone slightly more positive on Japan thanks to better news in recent weeks on the so-called ‘third arrow’ of prime minister Shinzo Abe’s policies to boost his country.
Looking ahead, after a decent run in equity markets through the spring, another period of consolidation during the summer is quite possible. The disconnect between bond and equity prices and economic reality is a concern, though it does still seem that the central banks will continue to support asset prices, and this liquidity continues to trump fundamentals.
What is helpful is that the economic data of late has been reasonably good, and the ongoing support of central banks and likelihood of interest rates staying low should be positive for risk assets.
We still, therefore, expect positive outcomes for markets this year, though it does appear we are in a period of markets going nowhere fast.
We may be in a holding pattern for a while longer; whether we break out to the upside or the downside remains to be seen. For now, we are happy to wait for newsflow and data to give us the conviction to increase the risk profile of our portfolios.
Gary Potter is co-head of multi-manager at F&C Investments
