22 January 2014
    
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Quarterly Economic Review
2014 - Towards a Brighter Outlook
by James McCarthy, Investment Analyst
 

At the end of December the outlook for the global economy appeared to be brighter than anytime in the previous few years, led mainly by growth in countries such as the US, Japan and EU member states. Such economic expansion would have a positive spillover effect for the rest of the world with world GDP is expected to grow between 3.5 per cent to 4 per cent in 2014. If realised, this would be an improvement on the c. 3 per cent growth rate expected in 2013 and the world economy's best performance since 2011. 

 

Half of global output is accounted for by the US, the Eurozone and Japan, meaning any expansion is good news for the global economy as the pick up in global demand boosts exporting nations economies. The US economy continues to strengthen reducing the unemployment rate. For three consecutive months, an average of almost 200,000 net new jobs have been created by employers (however there was a sharp step down in job growth in December) while consumer and business sentiment has been mostly strong. While the recovery in the Eurozone has slackened, importantly the currency bloc has exited recession and as a whole is expected to grow by nearly 1 per cent in 2014. The outlook is nonetheless poor for many of the member states and deflation may be a key concern in 2014 with the possibility of a double dipped recession across the whole currency bloc. Meanwhile, the political leadership in Japan is determined to exit the country’s long problem of deflation with Prime Minister Shinzō Abe's expansionary economic policies, which has acquired the neologism "Abenomics". While data is still not pointing towards any substantive trend, exports are growing rapidly, helped by a weakened currency and inflation is becoming re-established. Across the developed world, politics will again be an important force in 2014 and difficult to predict.

 

Emerging market economies are another side of the equation. China which recorded growth of 7.8% year on year, in the third quarter of 2013, faded concerns about a hard landing which was a positive sign. China is nonetheless expected to continue its structural slowdown in 2014 reflecting a shift towards more sustainable rates of economic growth. Demand for imports from other countries will still remain strong though. In India, the outlook is improving after some difficult years. While growth hit a four year low in early to mid 2013, growth accelerated modestly in the following quarter, helped by above-average rainfall. The turnaround in growth is also being supported by export growth, partly as a result of the weak rupee. Growth is forecast to be nearly 6 percent, up from nearly 5 per cent in 2013. In Russia, lower inflation should enable the Central Bank to cut interest rates, helping economic growth. Latin America also had an economic slowdown in 2013. The World Cup should give some boost to Brazil's economy in 2014, but the benefits will be offset by weak business confidence. While there is much pressure on many emerging nations to introduce structural reforms to set their economies on a growth path after many years of complacency, looming elections in many of these economies will likely continue to see politicians choose short-termism over reform. This will likely result in continuing pressures on emerging market economies. 

 

One main concern is the prospect of tighter US monetary policy which is a key risk to growth and stability. In 2014, the US is expected to begin reversing its Quantitative Easing (QE) programme, after pumping more than USD 3 Trillion into the US and global economies since 2008-2009. This will largely be seen as a reduction in stimulus but will nonetheless have implications for asset valuations with markets having become accustomed to cheap money. In mid 2013, the mere hint that a reduction in QE was under consideration resulted in a big sell off in emerging markets, currencies and commodities. The possibility of further shocks when QE tapering actually begins cannot be ruled out particularly that valuations and corporate profits are at high levels. A stronger US economy, combined with the end of QE, will also support the US dollar making imports to the US cheaper. The EUR/USD exchange rate is forecast to go from an average of 1.33 in 2013 to 1.28 in 2014. Meanwhile, on the energy front, the supply of oil is expected to pick up in 2014, due to strong growth in non-OPEC oil producing nations. Potential supply disruptions, in particular with OPEC producing nations, will act as a floor under oil prices.

 

Despite relatively low levels of GDP growth, global stock markets surged ahead in 2013 as confidence returned, showing the dislocation between the real economy and the markets. In the US, the S&P 500 Index closed at 1,848.35, up 29.6 per cent on the year, which was the largest annual increase since 1997. Stock markets across Europe also experienced their strongest annual performance since 2009, while in the UK, the FTSE 100 index finished the year up 14 per cent, its strongest performance in four years.

 

In terms of investing in 2014 investors should remember past performance is not a guide to future performance. Human emotion is one of the biggest obstacles to investor success which can often involve constantly changing investment portfolios, whether chasing a particular fund or sector that has performed strongly. On average, there is a bear market every 4-5 years. Investors who have misaligned their portfolios can risk large losses which can result in significant destabilising effects on the portfolios ability to grow over time. Investors should also be aware that positive returns aren't generated every year, either by the market or through managed funds. While investors should expect superior risk adjusted performance over time where their money is professionally managed, it is unrealistic to expect this type of performance all of the time. Getting investors to understand inevitable periodic underperformance is an important part of the investment process - no one wins all the time.

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