There are a lot of moving parts for investors to consider as we head toward 2014: The global economy is improving, the Federal Reserve is contemplating an end to its bond-buying program and the bull market in stocks is approaching its fifth anniversary. Michael Hood, head of institutional market strategy at JPMorgan, offered some helpful points in an interview last week – arguing that European stocks and U.S. cyclicals look good, while the Canadian dollar looks vulnerable. And as for the bubble talk, bring it on.
How do you feel the U.S. market is going to react to Fed tapering?
The market won’t react negatively if it sees the Fed reacting to an improvement in the economy. The negative reaction we saw back in May was associated with a Fed that seemed to be getting a little more hawkish. It was signalling tapering at a time when the market wasn’t quite seeing a forward-looking pick-up in U.S. growth.
Now, as we approach the the fairly imminent start of asset purchase reductions, the market is on board with the idea that the U.S. economy is going to strengthen next year – and so the reaction has been much less negative. As long as the market remains reasonably optimistic about the growth outlook, it will take modest reduction in monetary stimulus more-or-less in stride.
Although we have had tremendous gains in equities and people are asking if they should take some money off the table, now looks like a time when you should actually be positioned in what you might think of as some of the riskier parts of the market. In valuation terms and in terms of relative performance over the past few years, cyclical stocks haven’t done as well as you would have thought.
What about overseas? Emerging markets were hit particularly hard during the initial talk of tapering.
That’s a different story. What you don’t have there is the same degree of forward-looking optimism about growth. Higher rates in the U.S. are historically associated with lower capital outflows from the U.S. to places like the emerging markets. We’re seeing some cyclical benefit in emerging economies from stronger demand in places like the U.S., Europe and Japan, but other factors are weighing on EM growth. I think 2014 is going to be another year where EM growth is a bit sluggish by longer-term standards. And I think it will be another relatively challenging year for EM financial assets – but better than 2013, which was a total disaster.
So is the U.S. better positioned than most other regions in 2014?
It is certainly the economy where I would expect the most favourable swing in growth compared to 2013. On the other hand, U.S. markets have done very well, and equity valuations are no longer outstandingly cheap. So when I look around the world, I think there are some interesting opportunities outside the U.S., and I would emphasize continental Europe – a place where equity valuations still look quite cheap and where you have a catalyst to unlock some of that growth, in the form of the upturn in the European business cycle. I think there is room for people to be surprised by the persistence of a mild recovery, even if that recovery remains pretty modest.
Canada and the other developed commodity-economies (Australia and New Zealand) are places that have seen a very strong appreciation in currencies over the past decade or so. And it looks as though that is now starting to unwind. While the Canadian dollar has already slipped some, it still looks pretty elevated by longer-term standards.
Speaking of commodity producers, what is your view on commodities in 2014?
Mixed, at best. It looks like a less structurally-friendly world for commodities than was the case in the mid-2000s. Economic growth is picking up, but it’s still not great. A lot of supply constraints have been eased. We can see that in energy, and in mining as well. It’s a lot tougher to tell that “supercycle” story now than it was a few years ago.
There is a lot of discussion over whether U.S. stocks are in a bubble. What is your response?
I think it’s a healthy sign that we’re hearing that question. If you think back to when we were in an equity bubble, in the late 1990s, nobody thought we were. You had the hats and confetti and people on CNBC going berserk and so on. Sentiment can be a useful contrarian indicator – and what we’re not seeing at the moment is really elevated sentiment, particularly among retail investors.
If we look at valuations, stocks are clearly no longer cheap, and that’s particularly the case in the U.S. On the other hand, they are not really elevated by longer-term standards either. There are factors – low inflation, low volatility and relatively low bond yields – that in the past have been associated with people willing to pay elevated multiples for equities. Even though we’ve had some multiple expansion already, I think there is still some room for multiples to move a little bit higher.Report Typo/Error