Our Investment Commentary for Q4 2013 (1 October – 31 December 2013)

During the last three months of the year volatility continued to characterise much of the period, with strong gains unwinding in November before a Santa rally in December leading up to the end of 2013.

Looking back over 2013, the enormous economic stimulus from quantitative easing and the measures undertaken around the world to help restore confidence in the global banking system have had the desired effect. Equity markets have recovered strongly, economic growth appears to be increasing and the inflationary outlook looks benign.

Of course, it is important not be complacent. Government and private indebtedness remain very high by historical standards, the eurozone structural problems are unresolved and the high cost of living for large parts of the population in the UK and much of Europe is placing a severe strain on household budgets.

Improving Economic Outlook

UK

The UK posted its best growth figures for three years, growing by 0.8% in the third quarter. Most encouragingly, the growth appears to be across a number of sectors of the economy signally a broad-based recovery. Unemployment is falling faster than expected, with current estimates forecasting unemployment to reach 7% in the second half of 2015, the point when the Bank of England would consider raising interest rates. Inflation also appears under control, with the government’s preferred CPI measure of inflation hitting the target of 2% in December, the first time inflation has been within its target range since 2009.

Many companies reported better than expected earnings during the fourth quarter, buoyed by the improving economic conditions in the US.

United States

Whilst October started on a shaky note with concerns regarding the US government shutdown, once a last-minute deal had been struck, equity markets powered ahead. In particular, the US economy grew by a better than expected 4.1% in the third quarter of 2013.

The improving economic outlook in the US led to frequent market speculation with regard to the timing and extent of the withdrawal of the $85b per month economic stimulus. Finally, on 18 December, the US Federal Reserve confirmed that the support would begin to be reduced, initially to $75b per month. Markets responded very positively to this news, viewing it as confirmation that the US economy is on the road to recovery. The US S&P 500 index hit an all-time high, making it the best calendar year for US stocks since 1997.

Eurozone

Eurozone markets had a good fourth quarter, supported by the cut from 0.5% to 0.25% in the Eurozone interest rate. Unlike the US, where economic growth appears to be picking up, eurozone growth overall remains a worry despite Spain formally emerging from recession; strong economic growth and consumer confidence in Germany has been offset by continued weakness in Southern Europe. Inflation or rather, lack of inflation is a concern too, with the potential for a prolonged recession as countries struggle to deal with enormous indebtedness.

With regard to politics, political risks diminished. In Germany, Angela Merkel agreed to form a coalition with the centre-left SPD, in Italy Prime Minister Letta won a confidence vote and veteran Silvio Berlusconi was expelled from the Senate following a conviction for tax fraud.

Asia

In local currency terms, the Japanese equity market was the star performer of 2013, although in sterling terms it was eclipsed by the US due to a significant depreciation of the Yen. The Japanese equity market has been driven during the year by the enormous economic stimulus by Prime Minister Abe which has resulted in export-led demand following a devalued Yen. Whilst Japanese economic growth is modest, inflation data have been encouraging. Accordingly, Japanese monetary policy has focused on a growth agenda.

Elsewhere in Asia, markets welcomed China’s Third Plenum of the country’s leaders. This gathering resulted in some welcome reforms, such as the easing of the one-child policy and giving markets a ‘decisive role’ in resource allocation. Investor confidence in China also appeared to be returning in the fourth quarter, together with higher levels of exports. Taiwan and Korea posted some strong gains as exports of smartphones and cars powered ahead, and India continued to recover as the governor of the Indian central bank has helped stabilised market concerns. Other Asian markets mostly struggled though, such as Indonesia with a weak currency and high inflation, the Philippines in the aftermath of Typhoon Haiyan, and Thailand beset with political unrest.

Markets

The table below shows the performance of key global markets in local currency and UK sterling terms, including dividends re-invested between 1^st October and 31^st December and for the full year of 2013:

With the exception of most government bonds, investment markets performed strongly in the last quarter of the year, making 2013 a very good year for equity investors. Currency has played a decisive role in global returns for a sterling investor; this quarter and throughout 2013, sterling’s strength dented returns from major overseas markets, particularly in the case of Japan.

Outlook for January to March 2014 (Q1)

Looking ahead to 2014, we expect to see continued progress in the markets, building on the strong returns of 2013 following the improvement in equities valuations. The new year is likely to be characterised by a ‘normalising’ of interest rates as the economic stimulus is gradually withdrawn. This process will need careful handling by central banks so as to avoid unsettling markets or stalling economic recovery, as well as maintaining the stability of banks and keeping inflation within a sensible range.

Whilst we are unlikely to witness the heady returns of 2013, most markets continue to offer some attractive opportunities and in our view do not look over-valued. We continue to favour equities over bonds for medium to long-term investment on the basis of the improving economic outlook and rising bond yields as a consequence of the tapering of quantitative easing. For diversification, we expect carefully selected commercial property has the potential to deliver returns in excess of inflation. Cash is likely to continue to deliver unattractive below-inflation returns for the foreseeable future.

Our favourite market for 2014 is the UK. As investor confidence continues to grow, we should see further demand for high quality UK stocks and selected funds, particularly those paying above average dividends by profitable companies with strong business franchises. We also like some UK midcap and smaller companies, which should benefit as economic growth picks up during the year; there are some attractive unit and investment trusts for accessing this part of the UK equity market.

With a slow recovery still underway in Europe and central banks providing forward guidance, we hope to see continued support for markets as required. A further package of economic stimulus measures in continental Europe could give equity markets a fillip. Whilst challenges undoubtedly remain for the euro, there are a lot of good quality companies listed in continental Europe and many of these could deliver attractive returns in 2014, particularly where they derive a significant element of their profits from overseas markets in the US and Asia.

The US looks set to continue on its path to recovery and this is now reflected in the valuation of many US stocks. Whilst we expect market momentum to take the US market higher yet during 2014, corporate earnings need to continue rising to justify the higher valuations now being placed on many US companies.

China appears to have turned a corner with regard to economic recovery, so may once again provide some positive surprises in 2014.

Our Approach

Our approach is to help our clients benefit from attractive equity returns and target sustainable dividends from a diversified portfolio, on the basis of our diligent research and analysis to highlight interesting investment opportunities and mitigate risk as far as possible.

[Matthew Clark, Seabrook Clark Ltd, 14 January 2014]

Please note, our Investment Commentary is our view of markets and does not constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch.