Quarterly Investment Comment

Quarterly Investment Comment: Q1 2014

Review 

For the year with the indices noted above, North America rose 28.3%, Japan 24.9%, Europe 25.2% and the UK All Companies 20.8%.  Emerging markets, with the exception of certain oil-linked frontier markets in Africa and the Middle East, averaged a fall of 5%.  US natural gas surprised a bearish consensus with a 26% gain, Brent crude oil was flat and gold and silver fell an unprecedented 28% and 36%, respectively. Sterling weakened against the Euro but rose 2.3% against the dollar.  At year end Sterling, the Euro and the US Dollar bought 20-30% more Japanese Yen than they did a year prior.

The fourth quarter of 2013 accentuated the powerful trends in place all year.  Notably, N America rose 6.7% (and the Russell 2000 small cap index 8.3%), Europe rose 4.5% and the UK All Companies rose 5.4%.  The broad emerging market equity universe underperformed with a negative 1.5% return.  Bonds generally fell, with the yield on the benchmark US 10-year note rising 40bp to 3%.  US natural gas rose 18.8% and Brent crude oil rose 2.2%, while gold and silver fell 9.3% and 10.3%, respectively.

 What were the salient themes as 2013 unfolded?

 Developed vs emerging

Early in the year, growth signals in the emerging world were faltering and commodities were falling.  Investors turned their sights on more traditional investments like US stocks and the theme of developed markets outperforming emerging markets was born.   Adding fuel to this was the expectation that Japan’s new government would harness the “three arrows” of loose monetary policy, expansionary fiscal policy and structural reform to lift Japan out of deflation.

On 4 April, new Bank of Japan governor, Kuroda-San, stunned markets by committing to increase the central bank’s balance sheet to 60% of GDP by the end of 2014.  By the time global developed markets stalled in mid May, Japan had shown the fastest rate of appreciation in the history of that stockmarket.

The Taper

At his shareholder’s meeting in early May, Warren Buffett, in describing the positioning of global investors, suggested that “when investors perceive a change in monetary policy, it will be a shot heard round the world”.  Not more than a month later, Chairman of the Federal Reserve, Ben Bernanke, had put investors on guard that quantitative easing would be “tapered” and ultimately wound up, most likely by the end of 2014.

Investors’ reaction was swift:  A 100bp rise in US bond yields weakened re-mortgage and housing start activity in the US, while all manner of credit instruments but especially emerging market bonds (and currencies) fell.  Bond funds saw $60bn in outflows in Q2 alone.  This unexpectedly harsh market reaction threatened the “beautiful deleveraging” (where long bond yields would stay anchored while nominal GDP growth accelerated, allowing the US economy to roll over and gradually pay down its debt; described more fully in our Q3’13 commentary) that the Fed was trying to engineer.

Bowing to market pressure, Bernanke reminded investors that the Fed was not on a pre-set course and could “push back against a further tightening of financial conditions.”   In hindsight, that statement was all that speculators needed.  For the developed stock markets, at least, it was off to the races again–right into the end of the year.  From June trading lows, the S&P 500 surged another 18% in just over six months (small caps up 23%).

Outlook 

Looking forward, we consider the UK to be well-positioned for recovery and somewhat defensive with its international earnings power.  We continue to like the prospects for Japan.  The corporate earnings cycle is strong, monetary policy is loose (and the Yen weak), the government has a multi-year mandate and market valuation is reasonable.  Investors should continue to hold commercial property as recovery continues to boost demand.

Risk warnings
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future. It is important to note that in selecting ESG investments, a screening out process has taken place which eliminates many investments potentially providing good financial returns. By reducing the universe of possible investments, the investment performance of ESG portfolios might be less than that potentially produced by selecting from the larger unscreened universe.