This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Tom Becket says investors should expect some bumps in the road.
It has been a very challenging year so far for all investors, but particularly for the legion of bulls who proclaimed that equities would continue unopposed in their march to the sunny uplands. In fairness, I have not been immune from looking short term stupid, particularly in my projections that 2014 would be a year to remember for Asian equities for positive reasons. Admittedly, we are but three months in to the year and both the equity bulls and I might well be proved correct by the time the curtain comes down on the year. But for now, volatility is back, uncertainty is everywhere and sleep is at a premium.
Markets are jostling with a number of different demons at once. The first is that economic data is not strong enough to blast equities up to fresh highs. By implication, corporate profit growth has been passable, but not spectacular, and there have been some significant shortfalls creating nerves. In short, the growth rates that are visible around the world are probably enough to justify equities' current valuations but not drive them upwards.
A less obvious factor is the winding down of US QE (Quantitative Easing). The Bulls would argue that the Federal Reserve's balance sheet is still expanding, but only at a slower pace. The Bears would claim that the latest Fed meeting saw the 'hawks' claim supremacy and US interest rates are set to rise next spring. Our view would be that if the Fed feels it appropriate to raise rates then we should rejoice that they believe the economy can finally take it.
We expect UK rates to now follow a similar path to those in the US. We see the easy view that equities have only gone up because of US QE as utter nonsense. Yes, the loose policy might have helped equities rally, but companies themselves deserve credit for their good recovery. Yes there are some obvious examples of unjustifiable excess, such as US small caps, social media companies and biotech, but generally stocks look fair value to slightly expensive on a medium term view.
So to the big issues plaguing our minds. Let's start with the enfant terrible; China. I would just like to reiterate one conclusion again; if investors are right and China is doomed then you should be dumping all equities and heading for the hills. A significant slowdown for China has massive implications for global growth and I cannot reconcile my mind with the equity positive / China negative story that is oft-peddled.
Japan also has issues, but the slavish focus on short term data and the impending consumption tax hike ignores the heavy lifting taken on by PM Abe and Kuroda at the Bank of Japan. Patience is required, but on a three year forward view, rather than backward three month view, we are bullish still on Asian and Japanese equities. For now, we are being selective and will admit to not having a clue about what happens in the immediate future.
Whilst I should be castigated for my utter ineptitude in suggesting a good year for shares out East, I can find solace in the fact that diversification is working this year, with a number of different asset classes in the black, counter-balancing the many equity investments in the red. From here though the outlook is challenging and I have to confess to being more cautious about equities now than I have been in over five years. As we look across portfolios we can find more things that we want to sell than new ideas to buy. We are not calling a stop to the equity bull market (and we hope for all our sakes that it continues for some time yet), but we are trying to be realistic about short term potential.
To get more positive we need evidence of better economic data, helpful news from the East, confirmation that earnings will grow through the year and in to the next. Our base case remains for positive growth in the economy and in corporate profits in the next few years. However, the second quarter of the year is often challenging for investors and there is every chance that this year could maintain that tradition.
Morningstar Disclaimer
The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring your content on our website, please email submissions to UKEditorial@morningstar.com.
