What are the chances of that? How to invest for a good, bad or indifferent world economy in 2014


The outlook for 2014 is a vital thing to consider if you want to position your portfolio for changing market conditions - the difficult thing is knowing what to expect.

Many analysts believe we are in the midst of an economic recovery, which is usually accompanied by a move from bonds to equities as investors’ risk appetite improves, but others have a glass half full approach and belief threats are being underplayed.

The trick to taking advantage is weighing up your options and finding the right type of asset for what you think may happen. Stephen Cohen, chief investment strategist for iShares, runs through three economic scenarios to consider below and gives his probability of them happening.

Outlook: How do you think markets will perform in 2014?

Outlook: How do you think markets will perform in 2014?

Developed markets have performed well during 2013 as government policies such as low interest rates and quantitative easing in the UK and US, and a calmer eurozone helped foster economic growth.

If the positive sentiment continues and you want to bolster your investment portfolio, equities tend to do better in a growth environment than fixed interest as companies tend to pay bigger dividends and bond prices tend to fall when interest rates rise.

But the trick is not just entering the right asset class such as an equity or bond, at the right time, but the right type of security. For example, emerging market equities have been slow in 2013 but analysts are predicting a decent performance in 2014.

 

It is also important to take a long term view of the markets and not put all your eggs in one basket.

One way of preparing your portfolio is by assessing how  the global economy is going to perform and if it is going to grow too fast and even possibly crash.

Mr Cohen outlines three economic scenarios and how likely they are to occur.

The indifferent economy: Global growth stays low for longer – 55 per cent chance

In this scenario monetary policy such as low interest rates continues as does low wage growth.

Developed market economies will continue to bump along while Japan and Europe would continue their slow recovery.

WHERE TO LOOK

  • With political uncertainty in the US, minimum volatility strategies can provide a smoother way of accessing US equities
  • Differentiate between ‘emerging markets’. Countries with strong current account fundamentals, such as Korea and Taiwan, should see more resilient performance amid Fed taper concerns, as should China.
  •  European peripheral bonds have been a direct beneficiary of the European Central Bank rate cut.
  •  Emerging markets continue to develop as a source of income as their growth outlook matures.
  • Valuations for dividend payers outside of the US remain attractive.
  • Despite long-term tightening, high yield spreads are still above historical default rates
  • Data continues to suggest sentiment improvement in Japan and a potential deflation exit. The increasing correlation between equities and Yen weakening means that currency-hedged strategies are still opportune.


Things go well: Growth breaks out - 25 per cent chance

In his scenario companies spend more and banks improve lending to Japan and Europe.

Reforms in China progress and the US organises a smooth exit from quantitative easing.

Chances: iShares believes low growth is the most likely economic scenario

Chances: iShares believes low growth is the most likely economic scenario

WHERE TO LOOK

  • In the event that growth breaks out, emerging market equities will benefit as investors re-allocate to the asset class.
  • Brazil has been an underperformer in 2013 due to local monetary tightening and a deteriorating fiscal position. But beaten-up Brazil will offer value if emerging market growth positively surprises the market in 2014.   
  • If growth breaks out, rates will rise faster than current expectations. This suggests that in fixed income, investors’ focus should be on high yield and especially in shorter duration bonds and interest rate hedged strategies.


Things go bad: Imbalances tip over – 20 per cent chance

Although Mr Cohen says this is the least likely scenario, in this example current efforts at promoting growth go too far.

Negotiations over US tax rises collapse while recovery in Europe fades.

He explains: ‘An alternative scenario, albeit the least likely, is for global economic imbalances to tip over. Europe’s sentiment led recovery fades and there is an emerging market funding crunch as liquidity is withdrawn. China’s ambitious reform agenda comes at the expense of growth to create such a scenario.'

WHERE TO LOOK

  • Minimum volatility equities could offer cushioned access to global equities in a risk off scenario
  • Gold could provide a crisis hedge despite a challenging 2013 for the metal so far
  • If rates remain low the search for income will continue and dividend stocks with a defensive tilt and attractive valuations could prove popular


There are many ways to invest in the markets. You could buy individual stocks and construct a trading account, picking individual investments yourself while being careful to spread risk, or use an actively managed fund or investment trusts.

Or you could decide to follow an index or basket with a low-cost tracker fund or exchange traded fund.

Your costs will vary depending on the type of fund and the strategy, For example a passive tracker fund or an exchange traded fund will work out cheaper than an active fund.

Read more about the costs of investing. You can also practice being an investor using the This is Money Power Portfolio.