Growth investing in 2014

27th December 2013

Income may have been hard to come by in 2013, but capital growth has been in abundance. Any number of developed markets would have provided investors with double-digit returns in spite of a relatively weak recovery for much of the year. In fact, it was those equity markets traditionally seen as high growth – commodities, emerging markets – that were lacklustre.

Investment journalist Cherry Reynard looks at the challenges and opportunities for next year.

In 2014, the economic backdrop is likely to be more benign with all the major economies expected to show growth during the year. Economic indicators are pointing higher in the UK, US, Japan, China and even much of Europe. However, valuations are much higher than they were at the beginning of 2013 and so returns from stock markets may be lower despite this stronger background. Returns are likely to match corporate earnings. If they come through as expected, it could be another strong year for capital growth, but valuations are not supportive.

The obvious place to start for a growth investor is those areas that have not participated in this year’s equity market party, where valuations still look relatively cheap and therefore there is the greatest scope for growth. Commodities and emerging markets will be the key areas. The average global emerging market fund was down 3.9% in 2013, compared to a rise of 20.9% from the average UK All Companies fund. Commodities have fared even worse. Of the bottom ten performing funds in the global sector over the past year, five are commodities funds.

Emerging markets still draw mixed feelings. Trevor Greetham, head of asset allocation at Fidelity International, says emerging markets are still likely to struggle in a climate of loosening monetary policy in the US. This is putting pressure on emerging market currencies and inflating the borrowing in debtor nations. He also believes commodity producers such as Australia will continue to suffer.

That said, China is winning some backing after a poor run. Tim Cockerill, head of research at Ashcourt Rowan, says: “Barring any disasters, China might surprise investors. Valuations are low and in a better economic climate investors might start to look around and see that China isn’t so bad.”

Tom Becket, chief investment officer at Psigma Investment Management, agrees, saying that China is likely to reward a patient investor. He says of China: “Cheap valuations, miserable sentiment, huge scepticism and under-ownership make Chinese equities a classic contrarian bet. When one combines these factors with the major recent policy announcements that could be transformational to the path and stability of the Chinese economy, it is fair to say that I’m bullish. Risks exist and should not be ignored, but after two and half years of utterly abject performance, 2014 might be the year of the Dragon’s equity market.”

His pick is Allianz China, which focuses on Greater China and currently favours the structural growth opportunity in consumer-facing and IT companies.

On commodities, experts agree it is either the biggest growth story of 2014 or a quick way to lose a lot of money. Adrian Lowcock says: “Miners and gold may have longer term investment potential. Share prices have come off heavily and earnings are not falling as fast. A few people are starting to talk about the sector again.”

For those who would rather confine their growth options to developed markets, Europe is once again building momentum, seeing considerable fund flows. Cockerill believes it may do well, though there are plenty of asset allocators, such as Andrew Bell, chief executive at Witan, who believe Europe is still vulnerable to shocks.

In the UK, such has been the strength of the mid and small cap sectors that many are predicting a return to favour for larger capitalisation equities. This might favour a FTSE 100 or All-Share tracker, which will be heavily skewed to larger cap stocks.

The US wins few backers. Although the economy is likely to do well in 2014, particularly without some of the fiscal drag that has pulled it lower in 2013, markets are now very expensive. Although the US is always relatively expensive compared to other markets, it tends to lead rather than follow.

As such, many investors believe it has had its moment. Japan draws mixed feelings. Cockerill says: “Japan will be another interesting area. The market has been a little over-enthusiastic and tends to be disappointed if it doesn’t get instant returns from Abenomics. We are quite positive, however.” Abenomics is the last chance saloon – if it doesn’t work, the consequences for Japan’s economy could be disastrous.

Becket picks the Lazard Strategic Japanese Equity fund as a means to participate in any Abenomics-driven rally in Japan. He says: “Our view remains that valuations there are reasonable, corporate profits’ growth is underestimated and we are finally starting to see tangible evidence of the army of naysayers buckling towards the region and investing. We also that there are still plenty of sceptics to change their minds!” He believes markets could rise by as much as 15%, matching the likely growth in corporate earnings.

Cockerill says that in general the returns from markets in 2014 will not be as good as in 2013. However, there are still parts of global equity markets that offer opportunities for growth investors, but they will have to be selective on valuations.

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