Financial markets will have to re-engage with reality against a backdrop of significant macro and policy challenges, and investors need to be alive to probable volatility.
What happens if quantitative easing (QE) is withdrawn too quickly? What if companies don’t deliver earnings growth?
US company earnings have recovered and surpassed their previous peak. It is unlikely that 2013’s returns of close to 30 per cent will be repeated in 2014, but US equities remain attractive. Low energy and labour costs should support company margins. The best performers will be companies in the technology and consumer discretionary sectors.
In contrast, only half of European companies have beaten earnings expectations so far. The region remains beset by poor growth dynamics compared with the rest of the developed world and the stockmarket recovery of 2013 could easily herald a false dawn.
Europe is likely to return to positive GDP growth in 2014 for the first time in three years, but earnings growth is likely to be steady rather than dramatic. Stockpickers could be handsomely rewarded by concentrating on companies with strong business models, robust finances and dominant market positions.
The UK economy is still smaller than it was pre-crisis, but there was encouraging data in 2013 and GDP could grow up to 2 per cent for last year. Unemployment has fallen and the Bank of England’s (BoE) 7 per cent threshold may be reached in late 2014. However, positive data has not translated into profits thus far and companies are likely to end the year flat. The best returns are going to come from industrials and the consumer discretionary sector.
The year ahead will be a transitional one for bonds. Talk of QE tapering has already ended the bond market rally, although there is no evidence for a rotation out of the asset class, as demand from pension funds and banks remains.
In sovereign markets, yields should move gradually upwards, with the 10-year US Treasury yield at around 3.5 per cent by the end of 2014.
Meanwhile the gap between equity and bond yields should slowly start to normalise. In fact, corporate credit as an asset built for a slow-growth environment should perform well in 2014.
Emerging markets are a mixed bag and a wildcard in 2014. The announcement of QE tapering has caused significant headwinds in fixed income assets, and concerns over currency volatility and current account deficits remain. Equity valuations are attractive, but a stronger US dollar can have a negative impact on emerging market returns, while GDP growth in countries such as Brazil is unlikely to compare with that in the west. However, emerging market companies geared to an economic recovery in the developed world should not be dismissed.
On the upside, Mexico can look to solid growth linked to the US recovery and a lower manufacturing cost base compared with China. While the latter has impressed with the third plenum, stockpicking is going to be of particular importance.
The UK commercial property market could deliver good returns in 2014, as the economic recovery continues to boost demand. The main beneficiaries should be the South-East, as well as logistics and warehousing markets across the country.
Mark Burgess is chief investment officer at Threadneedle Investments