As the economy shows positive signs of an active recovery for the first time in six years and all eyes are on the Federal Reserve and Congress, the Investment Advisory & Management team (IA&M) of Bank of the West’s Wealth Management Group shared its investment commentary for 2014.
The IA&M team leads portfolio management for the Bank’s affluent and high net worth clients.
The expectation is that the US economy will continue its steady growth while international markets, specifically Europe, continue to break through their slumps. Meanwhile, the spotlight of pessimism continues to center on emerging market countries, especially China, despite above average growth versus developed markets.
The IA&M outlined its outlook for the equity, fixed income and alternative investment classes, in addition to potential disruptors which investors will need to navigate in 2014.
The IA&M team expects that global equity markets will outpace bonds and alternatives in 2014. Momentum in the US equity market can continue if companies see improved top-line growth as a result of pent-up demand, realization that interest rates will eventually rise, diminished fiscal drag and more balanced global growth.
The team does not see the equity market in a bubble or overvalued as long as revenues and earnings continue to grow, with S&P earnings estimated to grow at 6-8 percent in 2014.
Additionally, the rate of increase in capital spending could nearly double in 2014. Gains in capital spending could positively impact companies in the technology and industrial sectors. Companies will actually begin deploying cash once their managements have enough confidence that a global economic rebound will be sustainable, and after 6 years this seems to gradually be coming to fruition.
US equities are on solid footing, but will have more difficulty extending gains beyond earnings growth rates due to being further along in the recovery cycle than other major countries. Internationally, the team favors developed international equity market prospects; which are positioned for continued improvement as Europe transitions from recession to recovery.
The EU region’s equities could be poised for an intermediate breakout if fiscal drag continues to dissipate and growth rates accelerate.
Wade Balliet, CFA and co-head of the IA&M team, said: "The global growth forecasted needs to materialize for equity markets to continue to experience gains at a strong pace. Europe is the key component of the global growth story this year as the global economy needs stronger demand out of the region to realize the more optimistic predictions for growth."
Overseas data have recently improved, particularly in Europe. The European Central Bank (ECB) and the Bank of England are expected to continue to be accommodative in 2014. Europe may see more mergers and acquisition activities but challenges may still lay ahead for the region, with bank asset quality reviews and stress tests, the debate on a banking union, the ongoing struggle of austerity versus growth and the possibility of the extension of the ECB’s Long Term Refinancing Operation (LTRO). Avoiding disinflation will also be a challenge for the ECB in 2014.
The real danger and opportunity lies in emerging market countries, where a divergence has grown: some, like China, are growing at or above 7% while others like Latin America are closer to 3%, and still others like Brazil are facing recessionary pressures.
While better than average valuations exist in some of these markets the IA&M team thinks it is a bit too soon to start overweighting tactical positions due to cheapness alone. Timing will be paramount as momentum could continue to carry these markets downward, even as global growth accelerates.
The team believes 2014 will be similar to 2013 in that it will be a year of political debates and Fed action domestically, and a slowly improving international economy. High quality municipal bonds will perform relatively well as valuations remain attractive when compared to taxable securities, improving credit quality, and supply remains below historical averages.
Over the shorter term, the team continues to advocate spread or credit products, allocations to credit-sensitive sectors such as high yield, floating rate notes, as well as an underweight to duration. Foreign government bonds will likely outperform Treasuries as supply shifts in the market due to tapering, and the team maintains an underweight recommendation in Treasuries.
Cory Gebel, CFA and senior portfolio manager, said: "This past year proved to be volatile for bonds, but we continue to expect yields to normalize over the next few years from the artificially suppressed levels created by the FOMC."
Internationally, the team believes that global growth will continue to recover, but at a slower pace than investors expect. Emerging markets may continue to struggle as the countries attempt to address internal fiscal and monetary issues, effectively reforming current policy from strictly export growth to one more aligned with domestic growth.
With the start of the Fed tapering, the team expects increased interest rate volatility which will benefit alternative strategies that are able to take advantage of that volatility. The team believes global GDP growth may remain modest for several years; however, current valuations for the commodity market appear unsustainably low but will likely rise with global economic growth. Recent energy infrastructure investments should perform well as they are exploited, providing energy intensive industries with an advantage.
The team predicts a pick-up in real Gross Domestic Product (GDP) from 1.6 percent in 2013 to 2.6 in 2014. This increase is mainly attributed to an expected increase in industrial production, business spending, gains in housing starts and spending from an ever-resilient American consumer, and less fiscal drag.
Although the margin by which the Fed is trimming bond purchases – from $85 billion to $75 billion – is smaller than expected, it signals the Fed’s confidence in the underlying strength of the U.S. economy. A key factor in the Fed’s success in alleviating volatility in the markets will be in guiding the market to distinguish between tapering and rate hikes. Another challenge will be clearly articulating that tapering is not tightening.
Ben Baier, senior portfolio manager, said: "Due to tapering, mortgages and Treasuries will likely underperform the broader market during the tapering process. Housing may face some headwinds from not only the predicted pick-up in rates, but also from tighter government regulations on lending that are set to take effect in January 2014."
The Wealth Management Investment Advisory & Management group at Bank of the West tracks and updates these investment themes throughout the year and applies its recommendations to the portfolios it manages for fiduciary clients.