Stock markets, namely those of developed regions, flourished amidst the consumer optimism encouraged by consistently positive economic data, and even managed to avoid the potential pot-holes of a renewed European sovereign debt crisis, geopolitical tension in the Middle East and the US debt ceiling impasse, which all threatened to derail stability at certain points along the way. When markets did experience volatility, however, it was more often than not linked to trepidation as to how much longer central banks would continue to provide markets with support. Markets have come to enjoy the cushion provided by central banks’ extremely accommodative monetary policy, in which they have provided ample liquidity and pushed interest rates close to zero. Consequently, the market experienced tremors whenever news of recovery of the US economy in particular appeared to nudge the US Federal Reserve (the Fed) towards the inevitable tapering of these liquidity injections. Even so, when the US Federal Reserve ended months of nervous market speculation by finally announcing a definitive start to tapering in the new year, most stock markets had grown to feel sufficiently reassured that this was a welcome sign of economic recovery, and reacted with unprecedented ease.
The optimism of the most recent economic data appears to bode well for the growth forecast for 2014, yet it will probably be necessary to keep expectations of the scale of the growth in check. While we expect respectable rates of growth we do not see a huge rise for developed markets, and even emerging markets will probably grow less rapidly than we have come to expect. That said, the coming year looks set to continue to favour equities over bonds, particularly as bond yields look likely to rise further as quantitative easing (QE) tapering continues. Equities are currently cheap compared to bonds and offer higher yields, and what’s more, the global picture looks pretty good.
Surprisingly good economic data seems to have placed UK equities in particularly good stead with the rest of the global market, its 2013 annual return of +20.08% (as measured by the FTSE All-Share Index) falling short of global equity returns by a mere 0.6% in sterling terms (measured by the FTSE World Index). The FTSE 100’s top performers over 2013 have included household names like BT Group, Travis Perkins and Schroders. While large cap stocks can help to provide a solid and reliable core, however, it might be worth looking past it towards the FTSE 250 to find true value. Indeed, the FTSE 250 significantly outperformed the FTSE 100 in sterling terms over a ten year basis. The equity market often shows a degree of inefficiency, which means that a stock’s potential for high levels of growth and appreciation may not always be priced in by the market. Smaller stocks that cost less, yet look likely to appreciate in such a way, fall into the ‘value’ category. The stocks of large corporations and household names receive vast coverage in the media, by investment banks and brokers, and so it is less probable that the potential of such ‘growth’ stocks has not already been realised. Opportunities to buy (incorrectly) undervalued stocks are therefore more likely to occur among those that receive less coverage. Selecting stocks according to their ‘growth at a reasonable price’ or ‘GARP’ merits, however, can theoretically bridge this gap and offer the best of both worlds. What’s more, selecting GARP stocks that look able to capitalise on secular growth trends, such as population demographics, may also allow for the discovery of good value investments that herald growth in the long-term. UK-based house-building stocks, for example, currently appear to offer good prospects as they operate in a market of limited supply that is currently experiencing strong growth and demand. Conversely, sectors that currently experience intense public scrutiny and increasing regulations, such as financials, may not look as attractive at present, particularly those that are still attempting to emerge from the shadows of legacy issues. However, the rules are prone to change in a constantly evolving market, and a change in regulations has been known to suddenly increase the attractiveness of a sector or stock. Market leader BT, for example, has become an increasingly viable prospect following a relaxation of EU and UK regulation on how companies charge for broadband services. The market for 2014 as a whole looks to be heading away from the value sectors it tended to favour last year, towards growth-oriented sectors. Technology serves as a good example, where GARP might be found not in large brands such as Apple and Samsung, but rather in those that manufacture the component parts for these larger technology brands, such as UK domestic brand Information Technology.
As the UK economy strengthens, however, more domestic companies reach the point of being fully valued, thus posing a strong argument for ex-UK stocks. The sterling’s current position as the strongest of the major currencies may also create headwinds in 2014 by working against the UK export market, highlighting the appeal of stock markets further afield. Japan’s exporters are benefitting from the current weakness of the yen for this very reason, which was created by the incredibly aggressive monetary stimulus that Japan’s economy received to stave of its former prolonged deflation woes. Furthermore, from a sectoral perspective, while the UK is a strong hub for certain sectors, it does not do nearly as well in sectors such as health and technology where the US and Asia tend to host the clear market leaders. Growth regions, too, may offer a promising back-drop for investment. Emerging markets might have experienced the fall-out from the Fed’s withdrawal of stimulus, however their growth levels still easily surpass those of their developed counterparts. Emerging market equities can offer great opportunities, however we feel the key to successful investment is paying very close attention to each individual company’s fundamentals.
Conversely to equities, bond markets struggled over 2013. While the markets continuously awaited announcements from the Fed, global government bond yields spiked at every suggestion of a start to tapering. The 10-Year US treasury yield ended the year above 3.00% and does not look set to go materially lower as tapering continues into the year. Despite this, bonds’ diversifying nature within a portfolio remains important. A well-planned portfolio of investments will contain the means to deliver growth that will provide good performance during strong periods, yet will offer the diversity to offset potential during weaker periods by spreading risk. Good, yet steady returns can be achieved by striking a balance between the growth of investments as well as the diversification. With predicted bond returns for 2014 being either close to zero or negative, investors might benefit from a smaller allocation for the time being, yet the capricious nature of both bond and equity markets even in 2013 serves to highlight the need for diversification in fast-changing times.
AXA Framlington’s Managed Balanced Fund holds a mixture of equities, bonds and cash, with lead manager Richard Peirson responsible for the UK equity and bond portion of the portfolio, while his team of sector specialists manage the non-UK equity aspect. The Fund’s goal of seeking to achieve capital appreciation is largely realised by its medium cap bias, that is, companies with growth potential in the medium to long-term, rather than those that are already large. The theme of the Fund is that of simplicity, and instead of attempting to add value by continually rearranging the asset allocation it sticks to a rough 80:20 split of equities to bonds and cash. This allows for the value-add of good stock-picking within the equity part of the portfolio, while the latter proportion aims to smooth the excess volatility of equity markets as an ‘insurance’ policy. While it may seem less profitable to maintain this split at a time when the global bond outlook is not particularly good, it is upheld nevertheless in the same way that an insurance policy is renewed even following an uneventful year. While our equity outlook is optimistic, the very nature of an insurance policy is to exist in case of the unforeseen. The Fund at present favours gilts to overseas bonds, although looks to shorter-dated German bunds for their record as being some of the ‘safest’ in the world. Furthermore, the Fund’s current cash balance of around 14% is far higher than its normal allocation of around 5%, which is reflective of this negative sentiment towards bonds.
Source AXA IM UK 20 January 2013. Issued by AXA Investment Managers UK Limited, which is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No: 01431068 Registered Office is 7 Newgate Street, London, EC1A 7NX. A member of the Investment Management Association. Telephone calls may be recorded or monitored for quality. The views expressed do not constitute investment advice and do not necessarily represent the views of any company within the AXA Investment Managers Group and may be subject to change without notice. No representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Past performance is not a guide to future performance. The value of investments and the income from them can fluctuate and investors may not get back the amount originally invested. 18307 01/14.
