As we move into 2014, investors are feeling more upbeat, which is not surprising given that global economic growth is clearly picking up.
However, one has to remember that economic growth and stock market returns do not necessarily go hand in hand. If they did, there would not have been too many takers for developed market equities over the last five years and certainly not in areas such as smaller companies which have enjoyed some extraordinary gains in not only the UK and North America but also Europe and Japan, where economic activity has been particularly week.
However, while these stock market minnows have significantly outperformed large caps over the longer term, history shows that they can suffer shorter term periods of painful underperformance. We believe that we may not be too far from one such period and are therefore happy to be reducing our exposure with prices in our view now the wrong side of fair value.
For equities as a whole we still remain reasonably constructive and believe that they still remain better value than bonds in spite of the large divergence of returns last year.
We are aware of course that this bull market is now fairly long in the tooth and has so far been more about multiple expansion than earnings growth. However, investors have been deeply suspicious of this rally, focussing on defensive low beta stocks and have only recently become more interested in higher beta more cyclical names. Meanwhile there remains a huge amount of cash that has yet to be put to work which suggests to us that there is probably more mileage in the current bull market.
From a regional perspective, we continue to like Japan. Only time will tell if it really is different this time but if earnings growth ultimately drives share prices, then it is hard to ignore.
A more difficult call is how emerging markets will perform following their significant underperformance over the last few years. On the face of it, valuations look cheap on a number of measures but the asset class also faces headwinds and investors’ patience may well be tested again in 2014.
Within bonds, gilts are clearly more attractive than they were this time last year following a pick up in yields. However, we expect this trend to continue over the medium term although almost certainly not in a straight line.
With little sign of an increase in defaults, corporate bonds will probably continue to outperform gilts this year. However, we are aware that with yields at such low historical levels, the asset class is vulnerable to both a significant slowdown in economic growth as well as a faster than expected pickup in activity. This is particularly the case with high yield.
We remain keen on UK commercial property having significantly increased our exposure over the last six months. With a decent starting yield and capital values still a long way below their 2007 high in nominal terms (and much more in real terms) we would not be surprised to see another year of low double digit gains for the asset class in 2014.
David Hambidge is director of multi-asset funds at Premier Asset Management