How we got here

As every other year, 2014 started off with strategists and forecasters extolling their predictions for the year ahead, most of which – as usual – turned out to be completely wrong, and about as much use as sticking your finger in the air to test the weather.

The truth is it is impossible to predict the future. No one has a crystal ball. As the saying goes: “The only function of economic forecasting is to make astrology look respectable.” But what you can do is look at fundamentals, have processes and strategies in place, and prepare your investment boat for whatever the markets throw at it. To that end, it is worth looking back at what has been happening over the past year.

At the beginning of the year, who would have thought that 2014 would turn out to be the year of the bond? And that in equities, the main action would be centred on US equities – although through the large blue chips rather than the small caps. Interestingly, for the first time for several years the UK mid-cap underperformed the large cap in 2014, although not by anything like the gap in the US.

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The chart of year-to-date equity market returns does not really reflect the volatility that has hit markets this year. While overall volatility has hit record lows, February and the first half of October saw major falls in most equity markets as investors worried over the pace of economic recovery and the imminent unwinding of the US quantitative easing programme. The first turbulence in February was associated with poor economic data, and worries about European deflation and the ability of the Japanese prime minister Shinzo Abe to turn around that country’s economy. This all coincided with the US being hit by unusually cold weather that significantly depressed its economic growth.

Corporate earnings this year across most markets have been reasonable, led again by the US. Some commentators attribute much of this extra growth as financial engineering as US companies have continued to buy back significant amounts of their equity.

Emerging markets suffered from worries over the impact of the Chinese economic slowdown, combined with the potential impact of defaults of various wealth products that seemed to have been sold with an implicit guarantee – and yet many invested in various speculative mining ventures. There was also increased social unrest in various emerging markets, such as Brazil, Venezuela and Thailand, as well as rising tension in Turkey and Ukraine, all of which discouraged potential investors from emerging markets in general.

In contrast, China is a market that elicits great emotion from investors who either worry about the credit-fuelled boom or are attracted by the low valuations. The Chinese government continues to restructure its economy, and has allowed selective bonds to default and economic growth expectations to be gradually lowered. Exports, industrial production and retail sales have all been lower than consensus forecasts through 2014.

European markets have ebbed and flowed this year depending on whether investors have concentrated on the glass half empty – slow economic growth, deflation, the impact of events in Ukraine, exports to Russia/China and poor corporate earnings results – or the glass half full – the imminent implementation of Mr Draghi’s QE in Italy (probably in the first quarter of next year), combined with the beneficial impact of the recent weakening of the Euro.