2014 – a year for greater selectivity

Andrew Bell, Chief Executive Officer, Witan

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Equity investors advancing merrily towards the end of 2013 must hope that 2014 confirms the anticipated improvement in global economic growth. The cushion of low valuations which enabled equities to rally in 2012 and early 2013 despite disappointment on growth and corporate earnings has gone, so downgrades to expectations now would be damaging for sentiment.

Fortunately, there is reason for optimism. The US economy has shown resilient growth in 2013 despite a sharp tightening in fiscal policy, the UK has moved decisively away from the extended period of stagnation that followed the financial crisis and even Europe’s recession has bottomed out, although there remain sharp differences between the prosperity in Germany and other northern states and the painful adjustments underway in the Mediterranean. In Japan, 2014 will be a test of whether Abenomics can sustain growth beyond the initial “defibrillator bounce” created by the devaluation of the yen but the scope for a positive surprise exists, with scepticism pervasive. Even in emerging economies, which are seen as vulnerable to a reduction of global liquidity flows, an improvement in growth rates in developed economies creates a more positive outlook for global trade.

The pace of recovery remains subdued given the degree of monetary stimulus applied and the long period of adjustment since the banking crisis in 2008. When growth is low, it takes relatively little loss of momentum to rekindle fears of recession, which is the fear that has dogged markets in recent years. However, there are grounds for hope that 5 years of convalescence following the recession in 2009, together with the help of record low interest rates are finally restoring a stronger pulse to economic activity.

So, 2014 may be the first year for some time when economic growth is better than expected but it may prove harder going than 2013 for equity markets. This is partly because rallies in 2013 have raised hopes and partly that better news on economic growth will lead to (possibly exaggerated) fears that monetary policy will be tightened. Rather as the antelope on the Serengeti can sense coming rainfall long before it falls on their heads, financial markets tend to look ahead and may already have factored in the good news. Crowded trades, like crowded plains, can be vulnerable to disappointment (lions).

Watchfulness rather than fear seems the word for 2014. The widespread levitation of market indices since 2009 has taken away the safety margin required for a “blunderbuss/select by dartboard” approach to equity investment. However, valuations are not outlandish so if growth comes in as hoped there is scope for share prices to respond to improving earnings and dividends. Central banks have made clear they are more concerned about fostering growth than about inflation, so interest rates are likely to remain at historically depressed levels – a stimulus for economic growth as well as presenting an undemanding hurdle for other investments to beat.

So, selectivity is guiding Witan’s approach to which regions to emphasise in 2014 and our managers have been chosen for their willingness to choose stocks on their own merits, not because of their weight in an index.