Investment Comment February 2014
10th February 2014
Emerging markets have suffered as a result of the tapering of quantitative easing (QE) in the US, which has affected particularly the currencies of countries running current account and budget deficits. Several central banks reacted hastily to try to stabilise currencies and resist inflation. The Turkish Central Bank raised the one-week interest rate from 4.5% to 10%, and the South Africa Interest Rate increased 0.5% to 5.5%. From an investment point of view, it seems most unlikely that there will be a repeat of the 1997-98 emerging markets crisis. It is probable that the cut in QE is already in the price, and emerging markets, relative to the US, look good value. We think the long term trend remains positive.
In the US the dollar has strengthened as fund flows to emerging markets have reversed. Corporate earnings in the US are strong, 13% higher than the previous peak. Unemployment dropped from 7% to 6.7% in January, despite disappointing non-farm payrolls. The ‘fiscal drag’ of US tax increases, which subdued GDP by 1% in 2013, should stop hindering the economy during 2014. Rising industrial production normally translates into rising equity markets, and so we expect positive returns this year.
In the UK the IMF forecasts 2.4% GDP growth for 2014. The Office for National Statistics (ONS) reported that in the final quarter of 2013 we had the broadest expansion since 2006. Housing starts at 34,600 were almost double the levels in 2009. Manufacturing grew significantly, with car production at the highest level since the 1970s. The rate of unemployment fell more than expected to 7.1%, but we do not expect interest rate rises for at least 18 months. This creates a positive outlook for commercial property. We also believe that equities will continue to do well because it is reasonable to expect that earnings will grow robustly, justifying the higher valuations that resulted from growth last year. Housebuilders and general construction are likely to be key drivers of the UK economic recovery.
With stockmarkets having done well in 2013, there are inevitable concerns that they may have moved too far, and hence the recent correction. Despite the increases in 2013, the S&P500 index is still 15% below its post-1990 average. Long-term real interest rates are still low, which should mean that future cash flows are unusually highly valued. Add to that the increasing scope for innovation, with a growing pool of well-educated people worldwide, and we conclude that the prospects for investments continue to look promising.
As always, it is important to have a well-diversified portfolio invested in all the major asset classes, in line with your objectives and attitude to investment risk. Any changes in asset allocation should be gradual, because of the difficulty with precisely timing the markets.