Developed market stocks closed the month in positive territory, outpacing bonds, as the US Federal Reserve accompanied its decision to scale back monetary stimulus with a pledge to maintain interest rates at historic lows until the economy is firmly in recovery mode.
In its December rate-setting meeting, the Fed announced a modest reduction in its monthly purchases of government and mortgage-backed bonds, from USD85 billion to USD75 billion, citing an improving labour market.
But crucially for developed equity markets, the central bank also said interest rates would probably remain at zero “well past the time the jobless rate declines below 6.5 per cent”, a more dovish outlook than it had previously given.
Riskier asset classes, which had been in negative territory in the lead-up to the Fed meeting, abruptly changed course as the central bank’s statement appeared to convince investors that tapering did not amount to a tightening of the monetary reins.
US stocks, as measured by the S&P 500, hit record highs, with the index ending 2013 with a gain of some 26 per cent, its largest annual rise in 16 years. European stocks also ended the month on a positive note, taking their return over the year to about 20 per cent in local currency terms.
Emerging markets continued to be a weak spot.
Turkish stocks saw a double-digit decline as the country’s political establishment was rocked by a corruption probe while Chinese and Brazilian stocks also recorded heavy losses. Emerging markets equities ended the year in negative territory, undermined by concerns over the impact of a reduction in US monetary stimulus. They closed 2013 trading at a discount of some 25 per cent to their developed peers on a price-earnings basis.
Cyclical stocks fared better than defensive stocks in December, with technology, industrial and energy stocks the best-performing sectors.
Global bonds were down on the month, with US government bonds bearing the brunt of the sell-off. Ten-year US Treasury yields climbed to above 3 per cent, the highest level in two years. Within emerging markets, US dollar-denominated bonds ended higher while their local currency counterparts closed slightly down on the month. The Turkish lira lost 6 per cent against the USD while the South African rand and Indonesian rupiah also fell sharply.
Overall Pictet remain overweight equity as our leading indicators point to improving growth; Pictet shift bonds to neutral as they see scope for a short-term bounce.
Regionally Japanese and emerging market stocks remain Pictet’s favoured markets; they continue to underweight US stocks and cut mid and small cap stocks to underweight on valuation grounds.
Sector wise Pictet retain their cyclical tilt via overweight positions in energy, materials and industrials; Pictet reduce exposure to IT but raise financials to neutral. And finally Pictet continue to favour high-yield over investment-grade bonds as higher-quality debt is trading at expensive levels.
Source: Barometer January 2014, Pictet Asset Management