2014 Investment Themes

A World in Transition: Tapering, Restructuring, and Reform

We are pleased to present our selection of investment themes for 2014 and we wish all readers of our GPS research series happy investing in the year ahead. As in 2013, these themes are a mixture of macro and asset class views together with several ideas selected from our global industry analysis. At the start of last year, we advocated a positive view on equities, a neutral view on credit and an underweight view on government bonds and commodities. This outlook was largely borne out by subsequent market events, although oil and energy prices held up relatively well and we did not anticipate the scale of the ultimate recovery potential in Japanese equities where the Nikkei 225 index rose by a colossal 57% in calendar 2013.

Financial markets were characterized last year by lower volatility and reduced cross asset correlations against the background of stronger investor risk appetite and widespread belief that tail risks were fading. Looking to the year ahead, we believe that the tail risks which could stall or paralyze global economic recovery have diminished even further, although risks clearly remain in the euro area, in China and in political processes generally. Our base economic case, outlined in the first section of this report, is for global GDP growth in 2014 of around 3.25% and for consistent marginal economic improvement overall. Within this, we see the political landscape in the U.S. becoming more accommodating and, while there are risks for volatility in asset markets especially in the emerging world, we see the implementation of tapering as having minor consequences on real economies.

Over the course of 2014 as a whole, our asset allocation framework, outlined in the second section of this report, continues to recommend overweight allocations to global equities relative to other asset classes. We do not see equity valuations as stretched given a positive view on corporate earnings growth in 2014 and we also see dividend pay-out ratios rising. We address the issue of whether the world’s largest “mega cap” stocks will continue to underperform as was the case in 2013 and, indeed, for the past decade, and we look at what tools are available to CEOs to unlock the undoubted stock market value in many of the world’s largest companies. Given the stellar performance of 2013, we also look at what is in store for investors in Japanese equities in 2014 through the potential for further corporate reform and greater management emphasis on shareholder returns.

In contrast to equities, we believe that total returns are likely to be very low to negative in most major government bond markets. In credit markets, our strategists are more positive on Europe, where spreads may tighten further, than in the U.S. where we forecast spreads to widen over the next year. Our commodity forecasts remain mainly bearish, although correlations between commodities and other asset classes have dropped back to historic norms while commodities at least continue to offer a hedge for those investors who worry about geopolitical risks and supply disruptions. Around these views, we discuss some shorter term nuances and amplify some particular themes in other sections of the report.

We have selected two themes for 2014 that come from our global analysis across industry segments. These themes are property markets in China, where our team has conducted very thorough on-the-ground analysis, and an emerging growth opportunity in pension risk transfer.