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2013 – another good year for investors

2013 was notable for what did not happen: the US did not go off the fiscal cliff or default on its debt and the much feared inflation lift off failed to materialise; the euro did not fall apart despite a few scares involving Italy, Cyprus, etc; China did not hard land despite reports of "ghost cities" and claims of massive debt; and Australia did not have a recession despite the mining slowdown. What did happen was mostly positive:

The favourable combination of an improving growth outlook and low inflation meant the investment cycle remained firmly in the “sweet spot” for investors. But while a chase for yield continued on the back of low interest rates, it was not the simple "risk on" environment that many had become used to. Returns for the major assets are shown in the next table.

Source: Thomson Reuters, Morningstar, REIA, AMP Capital

2014 – still in the sweet spot

While there are still plenty of doomsayers around, we remain cautiously optimistic regarding the growth outlook. First, the cyclical pattern since the 1970s of major recessions every 8-10 years (mid 1970s, early 1980s, early 1990s, early 2000s, late 2000s) with modest growth slowdowns in between suggests we remain in a positive part of the cycle. The 2012-13 global growth slowdown has cleared the way for a continuation of the global recovery for the next few years which should help underpin growth assets.

Second, global monetary conditions will likely remain very easy. As a result of the 2012 growth slowdown, coming at a time when the world had not really fully recovered from the 2009 recession, spare capacity remains immense and so inflationary pressures are low. As a result while the Fed is moving to slow its quantitative easing program, the Fed Funds rate is set to remain near zero out to 2015. Japan and Europe may even see more monetary easing.

Third, the drag on growth from fiscal tightening is receding from around 1.3% of GDP in 2013 to around 0.7% of GDP in 2014. This is particularly the case in the US where fiscal drag will shrink from 2.3% of GDP to 0.6% of GDP and in the Eurozone where it will fall from 1.1% of GDP to 0.3% of GDP. In other words, the big fiscal tightening in Europe (believe it or not Greece is on track for a primary budget surplus this year) and the US is largely behind us.

Source: Bloomberg, AMP Capital

Reflecting this:

So what will it mean for investors?

The backdrop of improving growth but still low inflation and interest rates is positive for growth assets. But returns may be a bit more constrained and volatile than we saw in 2013.

What are the risks?

Beyond the risk of a short term correction in shares, there are three key “risks” for investors. First, shares could continue to surge higher as the strong returns of 2012 and 2013 reinforce fund inflows. It’s interesting to note that the US share market year to date is up 26%. The last five years in which it was up 26% or more, saw average gains in the subsequent year of 16% as the strong return attracted inflows. This of course would be a nice risk (while it lasts).

Second, a combination of Fed tapering, a faster growth acceleration and/or a pick-up in inflation could prompt a sharp back up in bond yields which would pressure yield plays and shares. Finally, on the flip side global growth could remain sluggish or deteriorate threatening deflationary pressures. This would be good for sovereign bonds and possibly bad for growth assets.

Another US debt ceiling standoff with Congress could cause uncertainty, but looks unlikely given the mid-term elections.

In Australia, the main risk is that the non-mining sectors fail to pick up pace leading to a sharper slowdown in growth rather than the upswing to 3% growth we are expecting. This could see the RBA cut the cash rate to 2%.

Investment implications

2014 is likely to see more volatility than seen in 2013 with more constrained returns. But overall it should be positive for investment markets as global growth picks up a bit and monetary conditions remain ultra easy.


 

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.