But in his latest note, U.S. Trust’s Joseph Quinlan takes a step back to look at the top 10 lessons of 2013, “since much of what transpired in the past twelve months will spill over into the new year.”
It’s certainly an easier task than making year-end 2014 calls, but Quinlan does a nice job summing up the past year.
Check it out:
Lesson 1: Don’t Fight the Fed and Other Central Banks
We hate to start with a cliché, but if investors have learned anything this past year, it is this: Don’t stand in the way of central banks determined and willing to flood the capital markets with liquidity via ultra-low interest rates and unconventional monetary policies. Don’t stand on the sidelines either, with easy money from the Fed and others (notably the Bank of Japan) inflating various asset classes as yield-hungry investors moved into riskier asset classes.
For some perspective, the Fed’s balance sheet has increased by $US1,017 billion since the beginning of the year; since September 2012, or the beginning of QE3, the Fed’s balance sheet has increased from 18.7% of GDP to 25.0% of GDP.
Lesson 2: The “Death of Equities” Has Been Greatly Exaggerated
Investors have heard and read a great deal about the “death of equities” over the past few years. Indeed, during the dark days following the market meltdown of early 2009, many market seers spoke of equities in the past tense — toast, too risky, and never coming back.
This underlying sentiment has made this market rally among the most unloved in memory. But we learned something in 2013: The death of equities has been greatly exaggerated. To this point and following five years of consecutive outflows, stock funds took in some $US134 billion in the first 10 months of this year, according to the Investment Company Institute. Strong inflows, in turn, have helped boost the major U.S. indices to all-time highs this year (nominal) and propelled indices higher around the world.
Lesson 3: Bonds Are Not Forever
The flip side of rising demand for equities has been declining demand for bonds — this, after investors pumped some $US1 trillion into bond funds between 2009 and 2012. Bonds have been on a losing streak since May, following comments from Federal Reserve chairman Ben Bernanke that the Fed was contemplating easing up on the Fed’s $US85 billion monthly bond-buying program. Through mid-November, the Barclays U.S. Aggregate Bond Index has dropped 1.4%; the index is poised to post its first annual loss since 1999.
Against this backdrop, market participants will likely look back on 2013 as the year that a three-decade bull market in government bonds finally ended. Though the absolute low in yields of 1.39% was actually reached in July of 2012, what really marked the coming shift in interest-rate policy was the savage backup in rates between May and September that followed the Federal Reserve’s “tapering talk.” Fed tapering combined with accelerating growth in the U.S. economy in 2014 portends higher bond yields. While we expect the backup in yields to be gradual next year, the bull market in bonds is certainly over. The beautiful affair between investors and bonds has ended. Diamonds are forever, but not bonds.
Lesson 4: The U.S. Economy Remains the Most Resilient In the World
For most of the post-crisis period, the chatter has been about the United States in decline, with America’s best days, according to the consensus, behind it. For debt-laden America, the jig was up.
Not quite. One of the lessons of 2013 is that the U.S. economy remains among the most dynamic and resilient in the world, with a rebound in housing, a rip-roaring automobile industry, surging exports, and the adoption of numerous game-changing technologies (think 3D printing, robotics, cloud computing)–all emblematic of an economy that never rests, is always reinventing itself, and produces more output than any other economy in the world. The U.S. economy is now in the fifth year of an economic expansion, with growth in 2013 not only tops among most developed nations, but also ahead of many key developing nations (think Brazil).
Lesson 5: The U.S. Energy Revolution Is For Real
Lending a helping hand to America’s comeback has been the revolution in the energy patch. Talk of the U.S. becoming energy independent only grew louder in 2013, thanks to figures like the following: In October, U.S. oil production exceeded imports for the first time in eighteen years. Presently, weekly U.S. crude oil production is 17.5% higher than year-ago levels and 56.1% higher than the levels of 2007. Natural gas production is up 27.8% from the levels of 2007 and 1.2% higher than a year ago.
All of the above has manifested itself in declining oil imports and rising exports of petroleum products. The energy bonanza has also buttressed household incomes via lower energy costs, and underpinned the global competitiveness of U.S. industry. Topping it all off, based on the latest projections from the International Energy Agency, U.S. production of natural gas will soon eclipse Russia’s, while U.S. oil production is expected to top Saudi Arabia’s by 2016.
Lesson 6: There’s Life Left In the Old World (Europe and Japan)
Left for dead and relegated to the dustbin of history, Europe and Japan, counter to the consensus, are alive and (somewhat) well. Japan’s Prime Minister Shinzo Abe has shaken up the world’s third-largest economy, aided and abetted by the massive money-printing operation of the Bank of Japan. Fiscal reform, a weak yen, and structural reforms (still pending) have jump-started an economy and stock market many investors had all but forgotten and ignored. The economy is expected to expand 2.0% this year, while the Nikkei has soared 48.3% year-to-date, making Japan home to one of the best-performing stock markets of the year.
In Europe, much work remains to be done to fortify and stabilise the euro zone. But the past twelve months have seen credit spreads narrow and unemployment rates peak; nascent signs of economic growth in Europe’s periphery have also emerged. The euro zone came out of recession in the second quarter of 2013, a pleasant surprise to investors and euro perma-bears expecting the worst: the breakup of the euro zone.
Both Japan and Europe confront a challenging road ahead. But investors learned that there is still life in these ageing economies in 2013.
Lesson 7: The Laws of Economic Gravity Apply To China
Yet another lesson of this year: What goes up in the Middle Kingdom, also comes down.
Investors could be forgiven for thinking otherwise since the Chinese economy has expanded 10% per annum over the past three decades, a stellar economic run that has lifted millions out of poverty and boosted growth around the globe, notably among the world’s primary commodity producers.
But those investors expecting more of the same in China this year were disappointed; 2013 was the year investors finally came to realise that China is not an unstoppable, world-beating economic juggernaut destined for global domination. To the contrary, China now finds itself at an economic crossroads.
The nation’s fork in the road is about the Middle Kingdom making the transition from export- and investment- led growth toward consumption- and service-driven growth. It’s also about avoiding the “middle-income trap,” or finding new sources of growth since the drivers and circumstances that propelled the nation to rising growth rates and rapid industrialisation in the past — low-cost labour and easy technology adaption/imitation — have dissipated as China has moved from lower-income to middle-income status. Investors have learned that not even China is immune to the laws of economic gravity.
Lesson 8: The Emerging Markets Are Not Quite Ready For Prime Time
A funny thing happened over 2013 — growth slowed in the emerging markets while accelerating in the three developed regions — the U.S., Europe and Japan. Global economic activity, as investors had come to expect it, was turned upside down. And heading into 2014, the U.S., the United Kingdom, Germany and Japan are expected to contribute more to global GDP next year than the fabled BRICs — Brazil, Russia, India and China.
Many developing economies were caught flat-footed in 2013, and left ill-prepared for the downturn in global trade (think Asian export-led nations); the secular decline in commodity prices (a la Africa, Latin America and the Middle East); and the prospects of costlier capital, courtesy of Fed tapering. The last of these sent shock waves through the emerging market universe in 2013, with investors, not surprisingly, retreating from emerging market equities, debt, currencies and other assets.
All of the above exposed a dark side of the emerging market growth story — that the emerging markets are hardly masters of their own domain, and still dependent on external variables (trade and capital) for growth as opposed to being drivers of global growth through more domestic- and consumption-led growth. For any investor hugely overweight emerging market equities, Lesson 8 was a painful one this year.
Lesson 9: The Commodity Supercycle Is Over
Not very long ago, farming was more profitable than banking, thanks to soaring demand from the emerging markets. Rapid urbanization, rising per capita incomes, the embrace of more western-like lifestyles among the middle classes of the developing nations — all of these dynamics in the first decade of this century placed unprecedented demand on the world’s physical infrastructure and triggered the so-called commodity supercycle.
And super it was — with the prices of virtually all commodities — iron ore, soybeans, wheat, zinc, silver, etc. — soaring. Not surprisingly, investors took notice and plowed billions into various commodity instruments.
According to the Commodity Futures Trading Commission, the total value of commodity index-related instruments purchased by institutional investors rose from an estimated $US15 billion in 2003 to at least $US200 billion by mid-2008.
But all cycles — even supercycles — come to an end, and following a post-crisis rebound in 2009 and 2010, prices across the commodity complex have since softened. Indeed, back-to-back declines in 2011 and 2012 were followed by a third year of lower commodity prices in 2013. Commodity prices have tumbled three years in a row; three strikes means you’re out, which is another way of saying that the commodity supercycle is over.
Lesson 10: Real Estate Never Goes Out Of Favour for Long
Real estate was at the epicentre of the financial crisis of 2008/09, leading many prominent bears to proclaim that real estate as an asset class was dead in the water; that it would take years — if not a decade — for real estate returns to recover in the face of massive oversupply, tight credit conditions and dwindling demand.
A key lesson of this year: Real estate never goes out of fashion for long. U.S. home sales have soared this year, with the spike in housing demand and home prices not only rampant in the U.S., but around the world. Global real estate transactions are now back to late-2007 levels. Think exploding demand in London, Tokyo, Istanbul, Singapore and many other parts of the world, with global real estate emerging as one of the most attractive assets in 2013.
In the end, real estate never goes out of favour for long — not with a growing world population, an increasing number of urban residents, massive and idle pools of capital in the emerging markets and rising national incomes across the world.
The Way Forward
There were many moving parts in 2013, and next year will be no different.
We know Fed policies will be a significant variable influencing the capital markets again in 2014; the markets, we believe, will adjust to tapering in an orderly way, while tightening is a story for 2015. The run in equities will continue; bonds will remain unloved. The U.S. economy will surprise on the upside, helping to pull along the rest of the world. China will reset and become a more attractive investment option with more quality growth. Per China, think less demand for physical commodities yet more demand for consumer goods and value-added services. Deficit-prone emerging markets will be buffeted by the effects of Fed tapering. Commodities will struggle, although agricultural commodities could surprise on the upside given underlying global demand. It should be another red-hot year for real estate, but fears about real estate “bubbles” may become more prominent as the year progresses.
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