The past year has seen positive, but unexciting returns for most investments – plus the odd shock such as the oil price collapse. Should we expect more of the same?
It may not have felt that way all the time, but 2014 was a fairly boring year. From 1 January to 19 December, virtually every major asset class has gone up in value. Some commentators will tell you that this is unprecedented and must be the result of quantitative easing, but it happens from time to time when market turbulence is low.
More than a few assets – such as the FTSE 100 and many high-yielding corporate bonds – only rose a little. In fact, UK stocks stand out as relative under-performers, almost flat on where they started the year. I reckon this will continue into 2015, as I’ll discuss in my next article. But in the meantime, let’s take a look at the surprises of 2014, and figure out what we can learn from them.
The seven big surprises of 2014
Paul Jackson, Source ETF’s research guru, has produced a useful list of events that were considered possible but not probable at the beginning of the year. These include:
1. Government bonds outperformed equities in many markets, even though yields started the year very low.
2. US ten-year yields declined almost continuously from 3.0% at the start of the year to 2.2%.
3. Greece, Ireland and Spain were among the eurozone economies outgrowing Germany.
4. Spanish bond yields fell below those of the US and the UK.
5. American stocks continued to outperform those of Europe and Japan – even in local currency terms.
6. Even in a strengthening dollar world, the top three equity, bond and currency markets were all in emerging countries (except for Portuguese bonds).
7. Saudi Arabia allowed the oil price to weaken by 50% over the year.
8. A European country won a Latin America-hosted World Cup (Germany thrashed hosts Brazil 7-1).
For my money, this last point was entirely predictable, given the German national team’s performance in European fixtures before the World Cup. Other than that, most of these were big surprises. So what do they tell us?
Firstly, US assets are seen as more desirable than most. Secondly, bonds can and have become ever more over-priced. I suspect these two trends will be sustained for quite some time yet.
We may all believe that fixed-income securities look terrifically overpriced, but that doesn’t mean we’ve seen the top of this remarkable bond bull cycle. If this continues, we could see ten-year bond yields for a whole swathe of developed-world sovereigns fall below 1%, joining their Japanese and German peers. That’s likely to mean that plenty of other non-sovereign bonds are dragged ever higher in price, pushing their yields to rock-bottom rates. US equity prices also continue to edge ever higher – with good reason given the vitality of the economy. It’s hard to argue that US equities are cheap, but few investors care. They want safety and confidence in deeply liquid assets, and that means US equities and bonds.
Then there’s the collapsing oil price. Wall Street analysts reckon that oil will rebound quite sharply in 2015, but I’m more and more convinced that oil prices will over-react in heroic style and crash below $50 a barrel, possibly even hitting epic lows of $30 a barrel. Eventually the markets will wake up to the huge opportunity on offer as share prices for anything energy-related crash.
Maybe at that point analysts at Morgan Stanleywill be vindicated for their recent call to be overweight energy stocks. The bank’s US analysts have looked at other oil price crashes. They conclude that “historically, the energy sector reverses strongly over the subsequent six months” in this sort of situation. “We analysed seven prior periods or phases when energy has underperformed the market by as much as it has recently, and in all cases, the energy sector outperformed the market over the subsequent six months.”
Steer clear of Russia
Oil may be tempting, but one siren call I will ignore is from those who say that Russia is worth a punt. James Butterfill, global equity strategist at private bank Coutts, is fairly typical of the gaggle of optimists who believe Russia is the great contrarian bet. They note that in rouble terms Russian equities have only fallen by 1.3% in the second half of 2014 to date, suggesting a bottomed-out market. “The MSCI Russia index is now trading at 0.4 times its book value – a 70% discount to emerging markets as a whole”, which is worse than even the 0.6 times reached during the credit crisis. “To find anything cheaper, you would have to go back to the 1998 crisis triggered by the collapse of hedge fund LTCM, when Russia’s equity market traded at 0.2 times book value.”
In short, Butterfill reckons that “Russian equities are oversold”. How best to profit from this? He and many others favour the oil and gas sector, “where pain from lower oil prices has been offset by great flexibility in capital expenditure and lower operating costs. Basic materials and exporters also fall into this category, which generally offers better dividend yields and currency protection.”
I think this is wishful thinking. I buy the Morgan Stanley line about rebounding energy stocks, but foreign investors have learned the hard way about Russia and the people who run it. I wouldn’t touch it myself and I suggest you don’t either.