February will mark the 20th anniversary of a key cyclical rotation in capital markets. The echoes are not confined to the calendar.
In 1994 the Federal Reserve (Fed) raised policy rates unexpectedly as the US economy continued to recover from a deep, real estate-led recession a few years earlier.
The move triggered a sell-off in stock markets; a traumatic setback for bonds; prolonged underperformance by emerging markets (but not commodities); prolonged outperformance by US and ‘growth’ stocks (peaking in the millennium’s telecom, media and technology bubble); and (eventually) a turnaround and outperformance in the dollar.
In 2014 we find ourselves braced for monetary normalisation after a deep, real estate-led recession a few years earlier. A setback in stocks has felt overdue; bonds still look dear, as most market participants assume policy rates won’t rise for a year at least; rust is growing on the emerging market boom; technology and pharmaceutical sectors are showing relative strength; and the dollar’s trade-weighted index is trading more pro-cyclically.
We’ve noted these historical echoes before. Admittedly, they don’t resonate equally loudly: phases and frequencies match only loosely in some cases. Nonetheless, each echo is a logical response to a common theme: a reappraisal of the US economic outlook. Estimates for US GDP growth in the second half of 2013 have quietly risen to a little over 3% – twice as much momentum as seemed likely as recently as the autumn.
So we enter 2014 expecting some volatility in developed stocks, but another positive year overall. We think the US can continue to outperform, alongside continental Europe. The lines between value and growth stocks are blurred these days, but we’d favour some of the latter alongside the more obvious cyclical and financial plays.
We think most bond yields will rise further, although the Bank of England rather than the Fed may be the first formally to revise its ‘forward guidance’, even though the US is growing most solidly. We are reluctant to overweight emerging markets yet, even though stocks there seem comparatively cheap. And we think the dollar’s trade weighted revival can eventually extend to the bigger crosses.
But we wouldn’t want readers to think that our entire asset allocation playbook is plagiarised from the mid-1990s. Commodities went on to perform strongly then, even as emerging markets languished, whereas now we are tactically wary. The recent super-cycle has probably boosted supply and reduced scarcity by comparison, and the high-profile gold price has of late been a beneficiary of systemic fears that weren’t there then, leaving it vulnerable if (as we suspect) they are not going to materialise now.
:: Andrew Miller is head of Barclays Wealth in Newcastle