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Stock Markets Outlook for 2014

While it may be difficult to repeat the excellent returns recorded so far this year, global equity markets are predicted to deliver at least double-digit returns in 2014

Andy Brunner 12 December, 2013 | 12:59PM

After two strong years for the MSCI AC World index, what are the prospects of another decent year in 2014? 

While it may be difficult to repeat the excellent returns recorded so far this year, equity markets are predicted to deliver at least double-digit returns in 2014. This view is predicated on strong US-led global growth (i.e. the US to attain sustainable expansion), still highly accommodative global monetary policy, short rates in the main economies to remain unchanged and bond yields rising broadly in line with consensus forecasts.

As the business cycle is now around mid point, confidence is growing and uncertainty waning and, there is little threat from rising inflation, given the degree of economic slack in most countries. This macro background should generate a decent upturn and acceleration in corporate earnings growth. An earnings recovery is vital to prospective equity returns as there is now far less scope for further revaluation-led gains.

In general, it is fair to say that from a historical context, equities are no longer cheaply rated and by some measures are fairly fully valued, although they remain extremely cheap relative to bonds. Indeed, it may not necessarily be their intrinsic value that drives money into equities next year but the prospect of another year of either extremely low returns or even further losses from bonds and negative real returns on cash.

What is the consensus view?

It has to be said that the consensus is as bullish as I can remember at the start of a year. Nearly all the main investment houses have fairly similar views, both in terms of economic growth and bond yield expectations, while global earnings growth of around 11% is projected by most of the investment houses monitored. The EU and Japan are expected to record EPS growth several percentage points higher than this, and the US a few percent lower.

Sentiment is virtually unanimously bullish with even a number of well-respected die-hard bears (value investors) believing momentum will carry equity markets higher in 2014. Nearly all of the major investment houses expect at least 10% global returns with 15%+ expected for many markets. Less upside is projected for the US, which accounts for nearly 50% of world equity market capitalisation and drags down the global average.

Which geographies are favoured?

In the early part of the year, greater uncertainty is expected in emerging market as Fed tapering may well unsettle emerging-market bond and currency markets. Further out there is scope for more downward revisions to growth and ongoing earnings disappointments. Valuations, excluding the top and bottom 10%, are nowhere near as low as the main indices suggest.

The US is also modestly underweighted but be warned, there will be no bull market without the US participating. US investors will also likely prefer their own market where they perceive the strongest recovering economy, the healthiest fundamentals and the best companies in the world.

The two overweighted areas are the EU and Japan. The former is still under-owned by institutional investors and with a global/EU recovery has the potential for 30% to 40% EPS growth over the next three years as operational gearing kicks in. Valuations are reasonable and very cheap against bonds, and with risks falling demand for equities is likely to strengthen. As for Japanese equities, they have the highest gearing to global recovery, earnings revisions are positive, valuations reasonable, further substantial QE is on the way, oil prices are declining and there could be a substantial swing away from bond investing by institutions and retail investors as Japan exits deflation.

The UK is neutrally weighted currently but has the scope to outperform later in the year. At the moment, strong sterling is impacting on overseas earnings (some 75% of the total) and the main defensive sectors, together with resources and energy, which are very well represented in the main UK index, generally have a high emerging market exposure and appear set for further underperformance.

What about sectors and market cap size?

From a sector perspective, a cyclical bias is favoured and sectors such as technology, financials and healthcare (preferred defensive) should perform relatively well. Utilities and telecoms remain underweighted. Mid/small cap momentum stalled recently after an exceptional year to date in most markets. One alternative where valuations are low is mega-caps but it is difficult to see them performing consistently (value traps) unless there is a restructuring/M&A catalyst. Portfolios with a mid-small cap bias will probably continue to outperform during a period of strong economic recovery.

The information, data, analyses, and opinions contained herein are those of the author, include proprietary information of Morningstar, and may not be copied or redistributed unless agreed to otherwise. Morningstar shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses, or opinions or their use. Indices mentioned are unmanaged and not available for direct investment.  Past performance is not a guarantee of future results. Morningstar OBSR is the brand name of Old Broad Street Research Limited and OBSR Advisory Services Ltd., which provide investment fund research and consulting services respectively.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Andy Brunner

Andy Brunner  is Head of Investment Strategy, Morningstar UK

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