2013 was a good year for equity investors, thanks to supportive central bank policies, signs of economic recovery and perhaps a little austerity fatigue. Cash is still enduring an erosion of value – the worrying thing is that the next home for risk-averse investors has traditionally been government debt, which currently looks significantly overvalued and could be one of the most risky asset classes of 2014.
Exercising caution in the form of regional allocation
So what does 2014 hold? The overwhelming tone at the moment is one of bullishness, and even the bears seem to be capitulating. We are positive about equities for the foreseeable future but with regional allocation playing an important role in the search for outperformance.
The US still looks a little expensive, and better opportunities can be found in Europe where we retain an overweight position. We’re also holding on to our overweight position in Japan, being careful to hedge against the falling yen.
Nevertheless, we feel there is a need for caution, even in developed markets. Sentiment is positive but could become excessive. Corrections are likely and will offer longer-term buying opportunities.
Here are some key themes for 2014:
Fed tapering. Now that US Federal Reserve governor Ben Bernanke has announced the unwinding of the world’s biggest ever financial experiment, a lot rests on the Fed’s forward guidance and its ability to communicate. This will be the biggest initial challenge for the new Fed chair, Janet Yellen.
Political interference. Political events may well cast a shadow. We have the mid-term elections in the US at the end of the year and we expect more action on the European project. Politicians have shown they can make mistakes but we wait with a degree of jaded optimism.
Central bank accommodation. Fed tapering aside, the central banks are still accommodative. With forward guidance taking centre stage, stability should prevail. Low interest rates will remain for longer, possibly into 2015, and this will be favourable for equities, particularly if growth improves further.
Abenomics. Japan’s Prime Minister has initiated QE on a massive scale. If it all works, and inflation does take hold, Abe will have pulled off a long-awaited turnaround. Failure is a possibility but a weakening yen and the upward pressure on wages should give a further boost to asset prices in the region.
Oliver Wallin is investment director on the multi-manager team at Octopus