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By Mark Phillips, 13 December 2013
“Most central banks, including the US Federal Reserve, have made it clear that they will try to avoid a sudden rise in interest rates and have signalled their intent to use steps such as forward guidance to support bond yields. Nonetheless, economic data across the developed world seems to be steadily improving, and consequently we expect long bond yields to grind higher in 2014.”
As always, investors will face both opportunities and pitfalls in the year ahead. However, despite general consensus that developed country growth should strengthen in 2014, Phillips anticipates any surprises to the economic outlook will be negative rather than positive. “Different opinions about the efficacy and desirability of current policy decisions and guidance abound, but there is a sense that the current easy monetary policy will remain in the short term. Questions however remain about whether the US debt ceiling will be resolved, when quantitative easing will come to an end, and what will happen if inflation starts to escalate in future. A policy misstep in any instance could potentially hurt the global economic recovery.”
Phillips says 2013 has been an eventful year where policy decision-making and its possible unintended consequences have distorted asset prices and the fundamentals underpinning them. Since the beginning of the year, global capital markets have been divided in their conviction of the breadth and depth of the global recovery. “Yet, despite several risks to the global economic outlook during the year, including the prospect of war in Syria, a partial US government shutdown and potential debt default, risk assets have continued to rally. For many, this is clear evidence of the distortionary effects of quantitative easing on the market mechanism.”
“On the face of it, financial and economic indicators are beginning to tell the story of a recovery,” says Phillips. The data now seems to suggest that Europe is crawling out of recession, fiscal drag is easing in the US and China’s growth is stabilising. Earnings growth at last seems sufficient to underpin a gradual but fragile economic recovery.
However, even if views of a global recovery next year are validated, it still does not rule out the possibility of a depressed long-run outlook. For many economists, monetary inflation unequivocally and without exception, causes economic busts. “If policy decisions have indeed fuelled intended and unintended consequences, then this leaves the global economy in a relatively fragile state, prone to sudden and violent corrections. We also have to ask whether policy measures over the last five years have been sufficient to correct excess global debt levels. While we have kicked the can down the road, at some point, the fundamental structural economic issues have to be addressed.
“While we still see further short term gains in risky assets, there is definitely an undercurrent of instability that has been created through highly accommodative monetary policy. Inevitably, markets will overreact to certain data points, misread certain central bank communiqués, and ignore certain risks,” Phillips says. He points out that thoughtful analysis, on both macroeconomic and asset class fundamentals, will be critical to navigating the global capital markets successfully in 2014.
“We still believe that despite a possible short-term correction, stocks will rise annually over the long term, and that bond yields will again look attractive once they have normalised on fundamentals.”
The current global landscape and markets are complex and faced with uncertainty, and 2014 should be no different.