The first quarter of 2014 has seen significant head winds in the world economy and investment markets. The end of the Federal Reserve’s QE program and the on-going concerns over the Chinese economy have all served to dampen investment sentiment.
While Growth in the USA and the UK continues to be robust, corporate earnings have disappointed. Most equity markets have been flat or slightly down since the start of the year. However while the first quarter has been disappointing there are marked improvements in the Eurozone economies. The threat of deflation may also spur the ECB to conduct its own QE program before the end of the year however these positive effects are unlikely to filter into investment returns until the 3rd and 4th quarter of 2014.
The Outlook for Bonds and Commodities still looks negative in the short to medium term however many markets may bottom out by the end of the year opening up some significant opportunities for investment returns in 2015.
Emerging market economies especially China still represent a significant risk and it may well be that Asia will now go on to suffer the third and final act of the shock from 2008. While we expect the impact on western equity markets to be limited it is probably prudent to trim any remaining emerging market exposure in portfolios. It is also a wise idea to minimise any exposure to Asian currencies you may have in your other investments.
After multiple highs the S&P 500 ended the quarter with an increase of 1.8%. The Fed has continued with its plan of a reduction of USD10 billion per month on its bond buying programme which investors have begun to live with. Markets remained robust following the Congress approval to raise the government’s debt ceiling “with no restrictions” until March 2015, which will mean a shutdown that was experienced in October 2013 will not be repeated.
In the first testimony before Congress, Janet Yellen, the new head of Fed indicated that there will be no changes made on the reductions in its bond buying programme (QE) and that interest rate will remain low in the short term. The Fed had also made changes to its forward guidance, removing its 6.5% unemployment target and stating that they will be focusing on a broader perspective. Due to low temperatures in the US, macroeconomics data was mixed. Though housing date was poor, consumer confidence in the US is currently at a 6 year high.
Due to bad weather conditions, the unemployment rate in the US increased in February to 6.7% from 6.6% in January and was reported to be 6.7% in March missing its March estimate of 6.5%. The fourth quarter GDP in the US was revised down to an annualised rate of 2.6% from its initial estimate of 3.2%.
Though issues in Ukraine placed pressure on equities mainly Europe, Eurozone equities outperformed other developed markets delivering positive returns for the first quarter. The Eurozone grew by 0.3% in the fourth quarter of 2013 compared to 0.1% in the third quarter. The purchasing managers index (PMI) indicated that the Eurozone has had 9 consecutive months of expansion. In a latest staff forecast released by the ECB, GDP growth was put at 1.2% in 2014, 1.5% in 2015 and 1.8% in 2016.
Inflation in the Eurozone has continued to be below target with the preliminary reading for March being just 0.5%, prompting IMF chief Christine Lagarde to comment that the ECB needs to take action. The ECB kept monetary policies unchanged in the first quarter, but will most likely announce a QE programme of 1 trillion euros to assess the effect on inflation.
In the UK, due to disappointing earnings results the FTSE All-Share index had a negative quarter falling by 0.6%. Larger companies bore responsibility for the FTSE All-Share’s decline (the FTSE 100 fell -1.3%) whilst mid – cap fared the best (the Mid 250 was up 2.6%). In terms of industry sector performances, healthcare, consumer goods and basic materials had the largest positive effect on overall index performance – the latter two having been negative contributors in the fourth quarter of 2013. Financials, led by banks, had the largest negative effect on returns in the first quarter.
In contrast to the fortunes of the FTSE All-Share index, UK economic data continued to improve. Stronger leading indicators, including the PMI report, spurred investors’ enthusiasm for the economic recovery. The release of detailed UK GDP for the fourth quarter showed a more balanced picture of growth. As a result, the Bank of England upgraded its expectations for 2014 growth to 3.4%; however, subdued inflation suggests a rate hike is not an imminent prospect. Employment data continues to move in the right direction, and its faster-than-expected improvement prompted the Bank of England to expand the indicators it will consider with regard to raising interest rates (the original 7% unemployment threshold is likely to be crossed soon). Fears of a bubble in the UK housing market grew as the Halifax monthly house price index rose 2.4% in February versus a 0.7% consensus estimate.
The Japanese equity market weakened over the quarter and the Topix Index produced a total return of -5.4% in sterling terms, -6.9% in yen terms. Investor sentiment was dominated by external factors, including some weak economic data from China and the evolving crisis in Ukraine. Relative sector performance was broadly the opposite of 2013 with areas such as airlines and pharmaceuticals outperforming and reflation beneficiaries such as real estate underperforming.
At the start of the period, the macro environment was dominated by the impact of the decision in December by the Fed to begin its exit from quantitative easing. The sudden re-emergence of a potential currency crisis among weaker developing economies unnerved investors globally. The Japanese equity market continued to have a strong correlation with the yen. The rise in international tension saw investors seek perceived ‘safe havens’; this resulted in a rise in the yen which in turn negatively impacted Japanese equities. Economic data displayed further evidence of Japan’s improving economic trend. The core consumer price index (CPI) – a key gauge of the country’s inflationary success which includes energy but excludes food – was up 1.3% year-on-year in February. February core CPI – which excludes food and energy – also showed a 0.8% increase and grew at its fastest pace in a decade. However, April’s consumption tax increase came into force on the first of the month and this is expected to weigh on consumption growth going forward. Furthermore, public attention has recently been diverted by renewed debate on Japan’s energy policy, specifically the short- and long-term use of nuclear power. Mr Abe’s apparent willingness to find new ways to antagonise Japan’s neighbours in Asia is an increasing source of concern and an unwelcome distraction from economic progress.
Asia (ex Japan)
Asia ex Japan equities posted marginally negative returns in the first quarter of 2014 as strong gains for South Asian markets were contrasted against losses for North Asia. The former reacted to positive domestic developments while the latter fell on the back of further tapering of QE, a slowing Chinese economy and the Crimea crisis that unfolded in Ukraine. China and Hong Kong equities were both down with worries over the slowing Chinese economy, as deteriorating economic data culminated in February’s official manufacturing PMI coming in at an eight-month low of 50.2. The combined January and February export data – to take into account the annual Lunar New Year holidays – disappointed, falling 1.6% year-on-year. March welcomed the National People’s Congress in China, where reforms for the country’s longer-term development drawn up at last year’s Third Plenum, are thrashed out and approved by a parliamentary body. Market optimism surrounding detailed market-oriented policy initiatives was dampened by continuing concerns surrounding the massive shadow banking industry, as the market’s first corporate bond default came to the fore.
Meanwhile, Taiwan bucked the trend for North Asia as it saw its market gain on the back of optimism over a cross-strait trade agreement currently being negotiated with China. Korea was down as continued worries over tapering, following Fed Chair Janet Yellen’s first FOMC meeting, hit its market. Meanwhile, in ASEAN, all major markets saw strong gains as domestic developments boosted investor sentiment. In Thailand, a bounce back was seen over the quarter as protests against the government of Prime Minister Yingluck Shinawatra eased with both government and opposition looking to ease tensions ahead of possible negotiations to resolve the impasse. The Philippines’ market continued on its strong run with positive economic data leading Moody’s to tip it to be the fastest-growing economy in Asia this year. However, the big winner was Indonesia, where the market was up by over a fifth, as central bank action to ease currency and current account deficit worries has continued to impress investors. News that popular Jakarta governor Joko Widodo, better-known as Jokowi, would be running in the presidential elections in July also boosted market Returns. In South Asia, India saw strong gains on similar developments as the local index hit an all-time high over the period. The rupee rallied to a three-month high while its current account deficit came down to a four-year low and further gains were cemented by the increasing likelihood that market favourite, Narendra Modi, will win the prime ministership in May’s general election.
In the emerging markets, investor focus was largely on heightened geopolitical tension between Russia and the West concerning Crimea. Weaker-than-expected macroeconomic data and concerns about the systemic risk of increased debt levels in China further weighed on investor sentiment. The MSCI Emerging Markets (EM) index underperformed the MSCI World index over the quarter. On the whole, the Latin American markets outperformed the EM index. Of these, Colombia was the strongest market, particularly towards the end of the quarter as data showed that the economy expanded by a faster-than-expected 4.9% year on year. In Brazil, returns were particularly strong towards the end of the period, largely due to increased optimism about a possible change in government following October’s presidential elections.
Emerging Asia performed broadly in line with the EM index with both Indonesia and India performing particularly well amid local currency strength and electoral optimism. China was the worst performing emerging Asian market as disappointing economic data releases, a sudden depreciation in the renminbi at the end of February and debt concerns following China’s first corporate debt default weighed on sentiment. The emerging EMEA markets lagged their wider emerging peers, led by poor returns in Russia. The Crimean peninsula of Ukraine was annexed by Russia in mid-March, following a referendum where it is alleged that over 97% of the turnout voted in favour of joining Russia. Ukraine’s new government state that the referendum has no legal basis and the European Union (EU) and the US have so far responded by implementing sanctions in the form of travel bans and asset freezes on a small but increasing number of government and other officials. The situation remains in a state of flux.
Fixed income markets defied end of 2013 predictions for a tough year ahead by broadly outperforming equity indices over the first quarter of 2014, despite mostly strong economic data from the US, UK and eurozone. Treasury yields fell sharply in late January, as volatility in emerging markets and weak economic data from the US sparked a glut of risk off trades. In February, emerging market debt recovered the losses sustained in January, and in March the BoA Merrill Lynch Emerging Market Sovereign Index posted further gains of 3.02% to reach an historic high. Similarly, robust economic updates from the US during February and March allayed fears of structural weakness in the US recovery. However, yields in Treasuries, gilts and bunds have remained depressed, latterly due to mounting concerns over the crisis in Ukraine and the cooling Chinese economy.
China’s March PMI manufacturing number came in at 48.1, falling from 48.5 in February to hit an eight month low. The world’s second largest economy also reported an 18% decline in exports in February, which forced China Premier Keqiang to assure markets that the government will support the economy if required.
The 10 year Treasury yield fell from 3.03% to 2.76% during the quarter. Gilts and bunds saw similar moves; the 10 year gilt yield fell from 3.02% to 2.76%, and the equivalent bund fell from 1.93% to 1.57%. In peripheral Europe, yields continued the longer term downward trend, buoyed by improving economic growth. In March both Italian and Spanish 10 year government debt yields dropped below 3.4% to reach their lowest point since 2005.
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