UK stocks have rallied this week – boosting equity investors’ confidence. But a sharper look below the lid of the FTSE reveals that almost all of that gain is due to just one stock – AstraZeneca (AZN).
The boom in the pharmaceuticals industry is hiding the truth: that developed market equities are not faring as well as expected. Small and mid-cap stocks in particular have come off this year, after two years of exponential returns. In 2012, the best performing fund was Standard Life UK Unconstrained, earning investors 44%. At the time, manager Ed Legget credited the fund’s 60% exposure to mid-cap shares. The specialist fund Neptune UK Mid Cap managed a return of 41% that year, while the Schroder UK Mid 250 increased by 36%. In 2013, smaller company funds such as Franklin UK Smaller Companies – which returned 51% - thrived.
Mark Dampier, Head of Research at stockbrokers Hargreaves Lansdown said that a stagnant 12 months often followed two stellar years of stock market returns.
“There was too much optimism at the beginning of this year,” he said. “Even usually positive fund managers such as Richard Buxton at Old Mutual were saying so. Stocks that rallied significantly last year, have dropped slightly. Equities performed well last year despite the pessimism, but now the mood has swung – just in time for the market to flatten.”
Last year, US small caps delivered 45% to investors. But so far this year, that asset class has not even managed 1% - while previous under-performers commodities and bonds have been the winning asset classes. In the first three months of 2013, developed market equities have returned just 0.8%, but commodities are up 6.3%. High-yield bonds were up 3%, corporate debt 1.8% - and even US government bonds managed to rise 1%.
“People have been calling the death of the bond market for years,” said Dampier. “But it hasn’t happened in quite the spectacular way many predicted. In fact, those fund managers who took a bet against gilts such as Thames River have fared very badly.”
Bond-giant Pimco’s Bill Gross has publicly lamented the bad press that has surrounded bonds for so long. But Gross could have the last laugh if Federal Reserve Chair Janet Yellen’s hints about interest rates come to fruition. Yellen has made it clear she will not raise interest rates just because unemployment or inflation reaches a certain level. Much like the Bank of England’s Mark Carney, Yellen has scrapped any concept of forward guidance.
Some economic prophets have suggested interest rates may not rise until the tail-end of 2015 – or even 2016 – which does not exactly spell bad news for bonds.
Canaccord Genuity Wealth Management agrees that the equity bull market is over. Global Strategists Robert Jukes and Edward Smith say that stocks are unlikely to deliver growth stronger than mid-high single digits over the next year or so, and even this requires global macroeconomic improvement towards the end of 2014.
Investors would do well to consider the macro-economic backdrop before jumping into markets too. While equities bounced last year because the threat of another Eurozone crisis dissipated, global markets are now considering the risks surrounding the Ukraine.
Russ Koesterich, BlackRock’s Global Chief Investment Strategist said despite the generally positive tone last week, the selloff on Friday was a reminder that investors may be too complacent about potential risks and that stocks remain vulnerable should the situation in Ukraine deteriorate further.
“The current low level of market volatility is, to some extent, due to the Federal Reserve’s still-easy monetary policy and benign credit conditions,” he said. “However, we also read the low volatility as a sign that investors are overly complacent and that potential bad news is not discounted into stock prices.
“It is impossible to predict exactly what might happen in Ukraine, but it does seem clear that if the violence continues to escalate and economic sanctions become more stringent, we are likely to see higher stock market volatility and increased selling.”
