Financial markets have begun the new year in a volatile manner. After a strong 2013, equities markets struggled in the first month of 2014 only to rebound strongly in February.
However, defensive asset classes such as fixed income begun the year strongly with bond yields falling across most major developed markets.
Given the extent of the rally in equity markets through 2013 we remain of the view that markets will struggle to maintain the same level of performance through 2014. The new year has the potential to be a more volatile year than 2013 with a number of competing factors in play, not least the potential for military conflict in Eastern Europe.
The big issue for financial markets in 2014 will be the impact of the US Federal Reserve’s tapering approach. Already we have witnessed a sharp decline in emerging markets since the Federal Reserve announced its intentions through the middle part of 2013. With ‘cheap money’ becoming less easily available, emerging economies that are running high current account deficits combined with a weaker economic outlook and poor political environment have struggled.
The decision by the Federal Reserve to reduce financial support reflects an improving outlook for the US economy. While month-on-month economic data is likely to be quite mixed, the overall trend appears to be positive. Equally, in other parts of the developed world, economies are making gains. In the UK, the economy continues to show signs of steady improvement supported by higher house prices and lower inflation. While in Europe the ‘green shoots’ evident through the latter stages of 2013 remain, although there remains a degree of divergence at a regional level and high unemployment levels, mixed growth and below trend inflation (i.e. deflation) remain an ongoing risk to any recovery.
In Asia, both China and Japan are pursuing reform agendas. Since its Third Plenum in Q4 2013, the Chinese government has focused on a number of key initiatives aimed at deliberately altering the current structure of the Chinese economy. While targeted economic growth may be lower at around 7.0% – 7.5%, this will still see the Chinese economy doubling in size over the next decade. For Japan the decision to continue its quantitative easing program to stimulate the economy may see the Yen remain below 100 (to the USD) while pushing up inflation towards the Bank of Japan’s 2% target. However, broader challenges for the Japanese economy remain, particularly around structural labour market reform.
Back home in Australia, the domestic economy continues to show mixed signals. The positive performance of financial markets has been offset by weaker economic activity, an increasing jobless rate, a ‘sticky’ currency and higher inflationary data. While we expect cash rates to remain steady at 2.5% for an extended period, higher inflation does reduce the scope of the Reserve Bank of Australia (RBA) to provide further monetary policy support to the economy. Additionally, the corporate environment continues to be challenging. The one positive for the domestic economy has been the pickup in house prices. With interest rates at all time lows the housing market has improved steadily with all capital cities recording higher prices, albeit off a low base. While we maintain a generally more positive outlook leading into 2014, there continues to be a range of factors that have the ability to cause a high degree of financial market dislocation and uncertainty. To this end we support a balanced view to any investment strategy with a disciplined focus on managing downside risk.
Past performance is not a reliable indicator of future performance. The information and any advice in this publication does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it. This article may contain material provided directly by third parties and is given in good faith and has been derived from sources believed to be reliable but has not been independently verified. It is important that your personal circumstances are taken into account before making any financial decision and we recommend you seek detailed and specific advice from a suitably qualified adviser before acting on any information or advice in this publication. Any taxation position described in this publication is general and should only be used as a guide. It does not constitute tax advice and is based on current laws and our interpretation. You should consult a registered tax agent for specific tax advice on your circumstances.