The one defining theme for 2014: Will the developed markets regain their position of leadership while emerging markets start to slip? Over 2008 to 2012, as China and the other emerging economies led global growth, there was talk of a "new normal", an Asian century and an emerging economies world.
That emerging market-centric worldview was rudely shaken in May 2013, when the first mention of a reduction in the monetary intervention or Quantitative Easing (QE) by the US Federal Reserve saw markets and currencies tumbling. In one month, the emerging markets index was down 15 per cent while various commodities fell as well.
Overall, 2013 saw the best performance from the Japanese (+57 per cent) and the US (+30 per cent) stock markets. In currencies, as Abenomics aimed to weaken the Japanese yen, the best returns were in the dollar-yen trade (+22 per cent). The worst performing asset class was precious metals with both gold and silver falling by more than 25 per cent each. Overall, global investors wealth increased by $10 trillion in 2013.
| WATCH OUT FOR |
- US market positive, but growth just 3.5 per cent
- Big opportunity in Europe
- Strong growth in Chinese stock markets
- Strong US dollar; weak euro and yen
- Inflation to moderate in India
- Fiscal deficit target to be met; current account deficit will trend downwards
Looking ahead at 2014, the IMF (International Monetary Fund) expects a 3.7 per cent growth in the global economy. The start to the year has been lacklustre with a fear of a China slow down, with the Fed continuing its "QE taper" and a looming emerging markets contagion with $7 billion having been withdrawn from emerging markets ETFs. EM (emerging market) currencies, starting from Argentina to Turkey to the entire EM world have fallen against the dollar, in a sharp fall reminiscent of the 1997 Asian crisis which spread to Mexico and Russia as well.
Even though the risk-on positioning is being questioned on emerging markets currency and contagion concerns, our preferred asset class remains equities. This is based on positive outlook for global corporate earnings which are beneficiaries of the strong developed economies growth. The top performing major stock market this year too could be the Japanese Nikkei, with a potential 27 per cent upside as per our forecasts. While the view on the US market is positive, the forecast growth will be much lower at around 3.5 per cent in 2014.
Europe remains a big opportunity, where we are forecasting a 14-16 per cent upside as the stronger growth of euro zone GDP to 1.5 per cent leads the market multiples higher. The Chinese stock market is also expected to see strong growth as it will benefit from strong external demand, reforms and higher fiscal spending.
Overall, in key parts of the global economy, there is improvement in corporate earnings, capex cycle and an accelerating mergers and acquisition wave. Historically, at these inflection points, investors pay premium multiples. In contrast, US and European markets are at mid-cycle PE valuations, while China is trading at a discount to historical valuations. The key risks to this outlook are political breakdowns or impasses around the world or escalating currency turmoil in the key emerging markets.
In currencies, US dollar is likely to be strong, while the euro and yen are likely to be weak. This is negative for commodities, especially precious metals which are likely to suffer from a combination of a stronger US dollar and the Fed QE taper induced reduction in global liquidity. The forecast for crude oil is also mildly lower with a self sufficient US and an Iran settlement both negative for oil prices.
Looking at India, despite a slowing economy, strong FII inflows of $20 billion in 2013 helped the BSE Sensex record an 8 per cent growth. However, interest rate hikes from July 2013, and a rapid depreciation in the Indian rupee dented this, with the dollar performance of the Indian stocks turning a negative 3 per cent. Indian bond funds also suffered negative returns post the July rate hikes, though for the entire year they gave positive returns. Gold, too, was down in keeping with the global correction, though by a milder 10 per cent in rupee terms.
Looking ahead, the Indian economy is likely to see growth of 5 per cent if FY 2014 and 5.5 per cent growth in FY 2015. The high inflation should moderate, while the fiscal deficit targets will be met and the current account deficit will trend downwards.
The mix of global and domestic factors have made the scenario very uncertain for Indian investors. So, it is advisable to invest in fixed income investments, with a preference for the shorter end of the yield curve. This would mean investing in short term bond funds, fixed maturity plans of one to three years tenure. The recent issuances of tax-free bonds were another golden opportunity to invest in quality names at near peak interest rates. The view on Indian equities is cautiously bullish, with an end-December 2014 target of 24,000 for the BSE Sensex. In terms of asset allocation, we maintain a neutral stance with a preference for locking into near peak interest rates on the fixed income side.