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Tales of the unexpected

30 December 2014

There has been much to be optimistic about in 2014 and plenty of surprises for investors too.

As ice storms froze the US and high winds lashed this side of the Atlantic, investors waking up on New Year’s Day 2014 had good reason, despite the inclement weather, to feel cautiously optimistic. The big questions for financial markets in 2014 had a positive ring. When would the US recovery allow the US Federal Reserve to return to a normal monetary policy? Would America in 2014 see the benefits of shale gas? Would the UK recovery follow that of the world’s largest economy? Would growth return to the eurozone and Japan, and would China manage its slowdown? Could global equities sustain the pace of the 2013 rally?

As 2014 draws to a close, the world’s largest economy is enjoying economic recovery (although severe weather stalled its earlier progress). The Fed has finished its monthly asset-buying programme known as quantitative easing (QE). America’s fracking boom has, in part, forced the Organization of the Petroleum Exporting Countries to keep pumping out oil at levels that are pushing down prices. UK economic growth outpaces other advanced nations; while the eurozone and Japan remain moribund, as China manages its slowdown.

Winter warmth

Back in January, markets were adjusting to the Fed’s recent decision to start to taper its QE programme, as the resulting flow of capital back into the US took a heavy toll on emerging market nations and their currencies, including Argentina, Turkey, Brazil, South Africa, India and Russia. The leading financial markets looked nervous too – and the rally since mid-2013 began to lose steam. Meanwhile, Mark Carney, the governor of the Bank of England, pronounced what would become a common pronouncement for the year – there was “no immediate need to increase interest rates”. Long-suffering savers faced with near-zero returns on cash would be given no respite as the UK recovery strengthened.

Despite the uncertainties that circled over the US economy, there were increasing signs in February of confidence among US investors, households and corporations. America’s economy, despite its winter freeze, had started to thaw; while the emerging market nations felt the ripple effect of US monetary policy. One winner was the London property market amid a surge of interest and sales to the international super-rich, attracted to the capital’s bricks and mortar as havens of stability in an increasingly uncertain world. The UK recovery was also buoying up commercial property, creating a revival, while the residential property price boom spurred talk of a UK housing bubble.

But it was the crisis in Ukraine, which had been brewing since pro-European protests began in Kiev in November, which was to provide another unexpected twist for global investors. After the Moscow-backed Ukrainian President Viktor Yanukovych fled Ukraine, Russia held a referendum in Crimea and annexed the peninsula. Investors started to retreat from the Moscow stock exchange; while Russians pulled capital from Western banks. However, global equity markets remained sanguine amid the escalation of tension on Russia’s borders and – despite the constant rumble of concern over China’s economic slowdown – focused on central bank developments in Washington.

Spring hopes

Although the International Monetary Fund at its April meeting warned that global growth was too weak for comfort, international investors retained their optimism as central bankers shored up confidence in markets. While the Fed continued to assert it would support markets with low interest rates as it retreated from QE, counterparts in Tokyo, Frankfurt and Beijing promised further stimulus. Words of comfort from central bankers were enough largely to assuage global equity investors. Wall Street was also looking increasingly bullish amid positive corporate earnings, although short-term investors were unnerved amid sharp price movements for technology stocks (underlining that herd-following distorts valuations and risks asset bubbles).

In the UK, the talk in the City in early summer was of US pharmaceutical giant Pfizer’s failed takeover of UK rival AstraZeneca. Fund manager Neil Woodford remained opposed to the American raid on the grounds that it significantly undervalued the Pfizer business. Markets in May also started to stir with the first sign of concerns over the lack of volatility. But, amid lingering concerns about global growth and the rumbling geopolitical threats in Ukraine and the Middle East, financial markets hovered near recent peaks.

As midsummer approached, the divergence between monetary policy and economic performance in the US and UK and that of Japan and the Eurozone had become more pronounced. The European Central Bank (ECB) in June cut deposit rates for banks below zero to stimulate lending and the bloc’s moribund economy amid near-zero inflation and growth. Investors expected Frankfurt to follow the lead from Tokyo and pursue looser monetary policy, while US and UK policymakers mulled over the timing of a future interest rate rise. Meanwhile, in London, the Queen’s Speech outlined the biggest transformation of Britain’s pensions for a century and an end to the obligation to use defined contribution pension savings to buy an annuity.

Summer clouds

In July, the introduction of an increased £15,000 allowance and more flexibility for ISAs brought further welcome choice for investors. Meanwhile, after the feel-good factor of the World Cup in Brazil, the international community was caught unaware by a whirlwind Islamist insurgency in Iraq that had spilled over from the violence and tragedy of neighbouring Syria’s civil war. And around the world’s leading financial centres, the lack of volatility had started to stir talk of calm before the storm, as Wall Street’s VIX index fell in July to its lowest level since before the financial crisis.

As summer progressed, concerns also began to deepen over whether markets had underestimated geopolitical risks. After the downing of Malaysia Airlines flight MH370 over Ukraine prompted further international condemnation, markets remained unmoved. Had abundant liquidity numbed markets to world affairs? In Britain, the debate started to heat up over the financial, economic and wider implications of a Scottish ‘Yes’ vote to independence, while the UK’s economic growth finally outstripped levels reached before the financial crisis. Meanwhile, the eurozone continued to shrink as the sanctions against Moscow hit its leading economy, Germany, and trade across the region, while Russia’s economy sank into recession.

The UK survived the referendum, amid a flurry of promises of further devolution for Holyrood and the rest of the kingdom. The UK’s financial markets wobbled temporarily around the September vote, but the volatility was short-lived – and the nation looked ahead to a new constitutional arrangement, a general election and, at some more distant point, resolution of the question of the future of the UK in the European Union. More immediately, amid a price war between the UK supermarkets and the German discounters, Tesco stumbled from a profit warning to the revelation that it had massively overestimated its first-half earnings, prompting a financial authority investigation and a share price plunge.

Autumnal storms

The concerns over world economic growth, particularly the lack of momentum for the eurozone, China’s slowdown and geopolitical threats, came to a head in October in a bout of market volatility many had anticipated in preceding months. The sharp movement of global markets seemed stormy at the time, but was short-lived. Markets by the end of the month had rallied again (offering a timely reminder about the need for investors to hold their nerve in the face of short-term ‘noise’). Investors were reminded that volatility in markets can offer long-term investment opportunities too.

With QE in the US finally ending in October, market attentions in November switched to Japan’s decision to expand monetary stimulus. Prime Minister Shinzo Abe caused further surprise in world markets, amid concerns that his ‘Abenomics’ stimulus programme was not revitalising the economy, by calling a snap election – which he resoundingly won in December. The Nikkei 225 Stock Average continued to climb over the period and surpass levels not reached since before the financial crisis. Wall Street responded positively over the month both to the Fed’s exit from QE and talk of monetary policy starting to normalise, as well as Tokyo’s further engagement in loose policy.

As 2014 closes, Moscow firefights a currency crisis as global oil prices tumble. Economies focused on energy production – such as Russia’s – face further pain while oil consumers enter a new era of cheap energy. Recent events demonstrate there are no certainties in markets or world affairs; but investors can – as always – draw some reliable inferences. Equities have outperformed other assets over the long term, and market volatility will come and go. World events and global economics are important; but, as markets enjoy the festive lull, the best response for long-term investors remains simple and seasonally apt: turn off and tune out.

The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and the value may fall as well as rise. You may get back less than the amount invested. Equities do not have the security of capital which is characteristic of a deposit with a bank or building society. The levels and bases of taxation and reliefs from taxation can change at any time and are generally dependent on individual circumstances.

Where the opinions of third parties are offered, these may not necessarily reflect those of St. James's Place.

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.

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