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Justin Urquhart Stewart shares his thoughts on the investment market in 2014…

Rule 1: Don’t lose the sodding stuff: Yes… it may be a simplistic platitude, after all one of the lessons of experience in investment shows us clearly is that all those little incremental benefits and gains you have made, can be wiped out in seconds by one misjudgement. In fact, some models show quite clearly that minimal action can be both cost effective and less risky. To quote another tiresome market phrase, remember “it’s time in the market; not timing the market”. The logic of this is not just the waste of money on spreads and commissions, but also the key element that often gets forgotten, which is that the yield provided from those coupons and dividends will often account for over 40% of investment returns. These payments and their compounding may not sound very exciting and may lack bravado, but they are probably the most valuable tool that investment managers can rely on.

Thus following this logic we had better take account of where we are most likely to see potential losses and ensure that we steer our investment around the ragged rocks of wrecked returns.

Let’s start with the USA, where we are going to see another election year of dominating politics, and with the potential to upset the burgeoning recovery. Let me leave aside the shenanigans of the “fudget” arguments that will be starting again soon, but rather look forward to the mid-term elections. The best outcome would be a clear winner so that policy – in either direction – can at last be driven forward. Sadly, the most likely outcome is another stalemate and if the Tea Party Republicans still stand petulantly in the way then any financial progress is going to be frustrated. This in turn could impact on government spending, corporate confidence and so ripple out into the wider economy. I pray for a clear decision – either way! Investors should watch these events develop as we get closer and be prepared to protect their positions.

Secondly; the Eurozone. Whilst the economic indicators are generally positive for many of the peripheral nations, the laggardly lack of reform in France still holds her back. Time for the President to have other things on his mind. However, there is still the spectre of unemployment and the understandable social tension unless tangible progress is seen. We should remember that the Chinese call 2014 the ‘Year of the Wooden Horse’, which if history serves me well, involves a group of Greeks coming out and trashing the city. Well, maybe not quite the same way this time.

The real concern in the Eurozone is declining inflation leading to the potential for deflation. After the main crisis, we have seen repairs taking place but there is still poor demand, a weak pricing pressure, coupled with government debt levels and a hobbled banking system. We therefore have the right atmosphere for deflation to potentially take hold. The prospect of a Japanese style Eurozone deflationary depression is also a possibility. The result could be that not only would the European Central Bank have to take action but that its primary “shareholder”, Germany, would have to change its attitude and policy towards such moves.

Thirdly; back in the US, we have forgotten over the holiday period, the Taper Tantrums that were threatened as policy marked a change. We are now on a path for Quantitative Easing (QE) reduction at least at a slow pace, but as yet we have not seen any action. We shouldn’t underestimate the sensitivity of this to markets in terms of timing and confidence. Personally, I believe that Ms Yelland will be in no rush to take any prescriptive action that might scare the horses, but fretful markets can be most immature.

Fourthly; let me go around the globe to the geo-political threats posed by the island dispute in the East China Sea. China’s sea sores – both here and in the South China Sea – have been festering for some time. However, the standoff with Japan is the more concerning because of the pride and “face” which prevents either party from standing down. With a right wing Japanese premier taking controversial actions by publicly visiting the military shrine, and an increase in defence spending, you can almost hear the ratchets turning in the dispute.

Now surely it is in neither parties’ interest to let this erupt into anything further, and it is in no-one’s interest to see this get out of hand in 2014 – especially with pragmatic political leaders and economic stability still being so valuable – or did people not say something similar in 1914? Is this a childish comparison? Not in my view, and the more it is aired hopefully the less chance there is of the situation getting out of hand.

For us in the UK, it seems we are going to be in continuous election mode for the next 18 months. First we have the Euro elections, then the Scottish Referendum, and then – of course – the general election next year. This means that we are going to be dominated by latter day student rhetoric of a poor quality and little in terms of substantive policy, I fear.

The Euro election may well see a wave of right wing “neo tea party” politicians gain a larger proportion of the vote across the continent and in the UK, UKIP may well see the same; not so much in its own seats, but in the effect it has of taking votes away, especially from the coalition parties.

As for the referendum, I just want to see “little scotlanders” have their say and move on. My view is that as a Scot, I should be proud and patriotic, but certainly not parochial. Scotland has a history of being an international country in attitude, in working and trading, so to revert back to

Medieval nationalism is a waste of time and money. We can still toast the “crown over the water” at dinner to satisfy our historical pride, but work with the rest of the United Kingdom for a better life for us all.

The general election run-up will distract us as the politicians preen and parade themselves in front of us with promises of favour with fervour. The reality is that it will be a distraction from building the economy and the sooner it is out of the way the better. One concern must be that around that time, if growth has been continuing then the Bank of England may well have moved on interest rates – albeit gently. This is bound to be a highly sensitive moment for the economy, especially for the stretched borrowers who despite dire warnings will probably not have prepared themselves for such a move.

So, with that short list of worries for the year should we be concerned? Not in my view, so long as we watch them carefully and be aware of their consequences and thus be prepared to act as necessary. For me the more worrying things will those unknown surprises that will explode without notice in front of us. All we can do as responsible investment professionals is to think strategically, but be ready to act tactically. Normally, I find that is the best way to “not lose the sodding stuff”!

Good luck!

www.7im.co.uk

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