A view of markets, risks and fundamentals in 2014
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As we move towards the end of the year, we need to think through what asset markets may offer in 2014 and it looks as if we should experience a period of consolidation for equities, with markets higher on a six to twelve months’ view, and expected to outperform both bonds and cash. Thus, we keep our overweight of equities in place as we do not see sufficient near-term downside risk to allow the tactical weighting to be different from the strategic weighting.
In terms of the risks immediately ahead, some tactical indicators do look extended, and in particular US corporate net buying (calculated as share buybacks plus announced cash acquisitions less IPOs and secondary offerings) has fallen to close to zero. This has been driven by very low announced cash takeovers, above-average new equity issuance and share buybacks having dipped slightly below their norm (which is unusual at this stage of the reporting season). On previous occasions when US corporate net buying fell from 3% of market cap to zero, the correction within the following three months has been around 7%, on average with companies in effect exhibiting the view that shares are expensive.
As for the fundamentals, whilst economies appear to be on an improving trend, global earnings revisions have lagged the shift up in global manufacturing new orders. This is particularly apparent in the US, where earnings momentum did not respond positively to the sharp pick-up in ISM Manufacturing new orders through the third quarter. The 13-week moving average (m.a.) of earnings revisions are marginally stabilising (this tends to be more reliable than the 4-week m.a., which is affected by the timing of the reporting season).
There’s also the worry that the consensus expects the first tapering of Fed asset purchases to be next March (although the survey was struck just prior to the latest FOMC meeting, which proved to be marginally more hawkish than expected), and there has to be a chance that tapering begins as early as January. One issue is that that whilst the Fed may be more dovish than many expect for any given level of growth, US GDP growth may turn out to be stronger than investors now expect in 2014.
In terms of what we can see from the numbers, US GDP growth is currently 1.6% year-on-year, even after fiscal tightening of 2.5% of GDP. Next year, fiscal tightening could be just 0.75% of GDP and as a result, the change in the fiscal stance could add nearly 1½% to US GDP growth. Thus, US GDP growth could end up being closer to 3%-3½% next year. Housing data (the NAHB) are consistent with 1.5m housing starts and housing adding another 2% to GDP growth over the rest of the cycle. Housing affordability on all measures is still attractive, and US house prices on the latest data are up 12.8% year-on-year, the highest annual growth rate since February 2005. In addition, housing inventories are still below their norm, and under half of peak levels.
Bond yields are a factor, but in the US, if anything, the bond market now appears realistic in its estimate of the first rate hike (May 2015), and against this backcloth, the macro economy can surprise positively and surveys (PMIs) are consistent with annual global GDP growth accelerating to 3.7%, compared to 2.7% in Q2 2013. This would put global GDP growth marginally above its 30-year compound annual growth rate of 3½%.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
