The bull market in equities has meant that even the worst of equity investment managers should have made money – on the basis that all boats should float on a rising tide. Actually what we also get to see is those who were decidedly leaky and, whether from costs, mistakes or incompetence, failed to provide real value to their clients.
After all most equity markets went up so all you had to do was stand on the escalator and apparently you were a successful investment manager. All you had to do was buy an equity tracker and that was the job done – the joy of hindsight – and additionally you would be able to throw investment risk, discipline and diversification to the wind.
However maybe things were not quite as simple as that. All equity markets did not behave the same way, with some very distinct differences. Japan had, at the beginning of the year, already started to benefit from the perceived expectations of the ‘Abe-san quiver of arrows’ policies. Equity indices leapt ahead as the policy of quantitative ‘dysentery’ deluged the market with government paper. The yen obliged and duly fell, exports benefited and then they reaped the additional benefit of imported inflation coming through to the domestic economy at last. However what was a simple concept providing an excellent return for clients was going to be for no benefit unless the currency had been hedged (see graph 1). In fact any gain would have been halved by the currency movement.
As for the eurozone, still there seemed little sign of growth in this area, and corporate results were reflecting the domestic weakness with growth seeming to be a distant hope and both consumer and company confidence still weak. So what chance for these markets? In fact figures below the surface – and certainly not ones reported by the Daily Mail – indicated that changes were occurring with current account balances in most of the peripheral nations making great strides from deep negatives to almost par. Unit labour costs were also dropping with Greece even finding itself at a lower unit cost than Germany. Despite this the gold bugs still held out for impending doom and euro collapse and bet that this would see a recovery in the yellow metal after the falls towards the end of last year, but to no avail (see graph 2). In fact as the year progressed, despite the negative headlines, many of the euro equity markets made progress, further supported by the victory by ‘Mutti’ Merkel in her national election.
Considering the almost pervasive negative attitudes towards the eurozone, it has thus been instructive to see the strength of some of those key markets, especially the German Dax (see graph 3).
In fact the laggard of the main markets has really been our own domestic FTSE 100. This index has always been inconsistent over the years. It has been a tiger that has changed its stripes. From technology, media and telecommunications, to banking to mining, the capital weighted index is open to the fashionable bullies that dominate, and thus suffers from booms when the larger stocks are popular and the reverse when they weaken. This time it has been the giant miners that have dragged down the rest and left the FTSE behind the emphatic gainers of the other leading markets. If ever there was a reason to look at the equal weighting indices of the ‘smart passives’ world then this was it. This year was the year that these index construction ideas started to gain acceptance in the mainstream as their logic of helping deliver a more predictable and less volatile ride came through.
On 22 May it was the day that at last the marketing puff that was the Bric fund fad could be put to the sword. Those mild words by the US Federal Reserve chairman Ben Bernanke: “in the next few meetings we could take a step down in our pace of purchase” were enough to scare the markets that they were about to lose their economic stimulant of choice. And so the quantitative easing addicts reacted by selling out of riskier emerging markets indices and running back to safety. Within a few hours markets such as Brazil saw both the Bovespa index and the Real currency drop. In fact what this dose of realism achieved was a perfect illustration of US business magnate Warren Buffett’s favoured saying along the lines of: You can see who is not wearing any swimming trunks when the tide goes out.
During that period of summer nerves we saw the difference between those more stable emerging markets and those with continuing issues. Yes, at last it was recognised that all the Brics were not the same and many of them in fact had little in common. South Korea, the Philippines and Mexico were finally differentiated from Thailand, Indonesia and others.
This year also saw some key developments in the bond markets. This was the year when we saw the start of the change in yields. For years bond investors have had the boom and boon of falling yields, providing built-in gains. That however was going to end and the reversal would also expose unwary investors and managers to built-in losses. The longer the duration, the greater the risk, and as the year progressed we could see the situation developing where traditionally safer investments were becoming riskier and traditionally riskier investments more attractive.
Wise managers sharply reduced bond durations with a view to holding short-term maturities to redemption, those that ignored such signs found themselves at greater risk.
To further underline the changes in attitude towards the eurozone, the continuing fall in yields of Italian and Spanish debt emanating from president of the European Central Bank Mario Draghi’s “do whatever it takes” statement back in 2012, continued even lower. At the time of writing, these eurozone bond pariahs currently have lower yields than US treasuries.
So what looks, at first glance, like a simple escalator of rising equities was in fact another complex year which turned many risk models almost on their head. Now for 2014 – which will be the same again but with different outcomes. What this all underlines is the need for great investment process, structure and discipline. Good luck.
Justin Urquhart Stewart is marketing director of 7IM
Key Points
All equity markets did not behave the same way, with some very distinct differences
There seemed little sign of growth in the eurozone.
The laggard of the main markets has really been our own domestic FTSE 100.
