A Year of Two Halves

By Noel O'Halloran, Thursday, 5th January 2012 | 0 comments

Asset returns in 2012 will be positive but most likely modest. The first half of the year will remain tricky and will be similar to H2 2011, as equity markets are set to remain range bound and volatile. The two major debates surrounding the state of the global economy and the fate of the eurozone will continue to dominate. For the second half of the year, there are reasons for optimism and I expect a more positive environment.

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While not a vintage year in return terms, 2011 certainly will be remembered for its various geopolitical shocks and macroeconomic events. The first half was noteworthy for the Japanese earthquake and the Arab Spring uprisings, and the second half was dominated by the eurozone debt crisis and by fears of an economic double dip in the global economy.

For 2012 my expectation is that asset returns will be positive but most likely modest. The first half of the year will remain tricky and will be similar to H2 2011, as equity markets are set to remain range bound and volatile. The two major debates surrounding the state of the global economy and the fate of the eurozone will continue to dominate. For the second half of the year, there are reasons for optimism and I expect a more positive environment where equity markets rise to higher levels, supported by positive fundamentals from valuation and earnings. Fixed income markets should experience a trickier year and core sovereign bond markets are set to produce negative returns.

In making these forecasts, my three core assumptions remain:

  1. The global economy will survive the mid-cycle slowdown of recent quarters and we will NOT see a double dip recession.
  2. A “disaster scenario” for the eurozone will be avoided.
  3. China will avoid a hard landing in its economy. I expect growth to continue to slow but from very high levels of 10% to around 8%.

Difficult first half of year

The early months of this year will be difficult for equities.

The eurozone crisis is far from over and we are very likely to see a further bout of turbulence as a result, with Spain and Italy’s very heavy financing schedules in the first quarter being a possible catalyst. Eurozone economic data should weaken as a result.

But there are potential problems elsewhere as well. The markets will remain anxious about a “hard landing” for the Chinese economy, while banks globally will continue to de-leverage hence dampening activity, and earnings expectations will need to be revised downwards in line with slower growth figures.

Second half to be more positive environment.

As we proceed through the year a number of the risks events mentioned above will diminish. Neither economic nor earnings growth will suddenly “stop”, and the economic cycle will continue. The key support of markets remains in place, i.e. the strength of company balance sheets. Companies remain healthy and generally have very strong cash balances to deploy into merger and acquisition activity, dividend increases, or share buybacks.

Central banks will remain market friendly and I expect that emerging market central banks will loosen monetary policy, as inflation ‘rolls over’, giving central banks much more scope to ease. And in the eurozone, the recent funding facility for banks announced by the ECB is a very positive development.

Importantly, as we enter 2012, commentators are predominantly cautious and investor positioning globally appears to be neutral at best. This is actually a positive indicator for investors, indicating that many investors are already underweight their neutral benchmarks and therefore have limited scope for further selling, so there is plenty of scope for contrarian investors to be quite optimistic on this basis.

At Kleinwort Benson Investors, we continue to analyse all these fundamentals and to manage your portfolios accordingly. The market environment we envisage will require continued active portfolio management taking into account reward and associated risk.

At regional level, after a challenging 2011, emerging market equities provide a very attractive opportunity. At stock selection level, we will continue to emphasise companies with strong fundamentals, i.e. balance sheet, cash flow and management. Investing in companies with higher than average and growing dividends was a winning strategy in 2011 and I expect this to continue. Company management will continue to provide strong leadership through their actions - leadership that seems to be lacking in the political arena.

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Recent blog posts

During 2014 we recorded new highs for global equity indices as well as recording the sixth year in a row of positive returns from global equities. This was achieved despite many headline challenges be they geo-political or simply the ongoing challenges of the muddle through growth struggle for many of the world’s economies. From my general perspective, this constant ‘barrage of challenges’ to the recovery scenario was to be expected and has been a feature of the global equity recovery since March 2009. Global bond markets have also continued to hit new highs confounding all negative predictions (including yours truly) once again.

For 2015, I believe we can expect more of the same, albeit with more volatility than recent years. While the global equities have been in a bull market now for six years and is therefore quite mature, I don’t believe the bull market is over but do believe investors should expect more modest single digit returns for 2015. The lesson from recent years have been that while ‘hits’ have been many and frequent they are transient and eventually overcome by improving fundamentals and central banks that keep the recovery underpinned....so buy the equity dips!

Why more modest returns?

  • The key reason is that equity valuations are no longer cheap and I believe that returns should be more in line with global earnings growth – which I expect to grow by 6%. Over recent years strong double digit returns were driven both by earnings growth and an upward revaluation of P/E multiples. Although this re-rating could continue, it’s not my central expectation. This also underpins my strong preference for high but sustainable dividend yields as a component of total return.
  • Earnings themselves have become more dependent on top line growth as the impact of significant margin improvements over recent years lessens. In a muddle through growth environment for many economies, robust top line growth is not to be expected
  • One key reason to expect higher bonds and equity volatility is that the Federal Reserve (Fed) will change course and commence raising US interest rates this year. The US itself has been a strong driver of the market and economic recovery and low US interest rates have underpinned this. We don’t expect the Fed will make a policy mistake but that’s not to say that markets won’t experience another one of their ‘transient wobbles’ when it happens

What will we be watching?

  • Top of the list over the first quarter will be the euro (again). Click here to see our separate blog of Jan 7 for our views re same  
  • The dramatic oil price fall of late has been a significant market feature. I expect the majority of the fall is now complete and my running assumption is that the oil price stabilises around current levels in a range, perhaps for a number of quarters
  • Global central banks have remained the bedrock of the global recovery and while the Fed may change direction in 2015, I don’t expect the global central bank underpinning to change. While much negative energy will likely be expended worrying about the Fed, a corresponding positive may emerge in the form of the ECB embarking on a more radical quantitative easing programme, the Bank of Japan continuing to stimulate and many Emerging Market economies may surprise with more stimulative policies (both fiscal and monetary easing).

What could surprise?

  • The markets to date have had a very nervous and negative reaction to the rapid oil price fall. They haven’t yet however put enough emphasis on the positive benefits of this fall.Over coming quarters, I expect we will see improved consumer spending, enhanced profitability in sectors such as transportation, and improved growth in countries (often Asian) which are large importers of oil. Lower inflation from lower oil prices will be written up as ‘deflationary’, but it is a benign deflation that actually benefits rather than hurts the beneficiaries. So while the damage to certain sectors such as oil stocks or countries such as Russia has been immediate, I think the beneficiaries haven’t yet been properly rewarded. Indeed, from our perspective many sectors with little direct exposure to oil have been severely overly-punished we would argue, and provide opportunity for investors.
  • At a regional level, having been hit with many concerns over recent years, Emerging Markets are increasingly off the radar of global investors.  I feel that they are becoming a forgotten asset class. Against a background of attractive valuations, reasonable fundamentals and a real possibility of interest rate cuts, Emerging Markets could be a surprise winner for 2015.
  • Another beaten up asset class for the contrarian investor to consider is broad commodity investments once more. They certainly could perform much better in an environment of increasing confidence surrounding global growth and a move to a more ‘risk-on’ environment. I’m not convinced at this point but perhaps one to revisit through the year.

To conclude, I believe that 2015 will be a positive year but one with more modest returns and with more volatility to be expected. Equities remain the asset class of choice against pretty much zero returns on cash and bond markets fundamentally unattractive in our scenario. Central banks will remain central actors on the stage, although their roles will change with the Fed likely to become more the ‘bad’ guy and the ECB and others to become increasingly centre stage. 

Noel O' Halloran, Chief Investment Officer

There is more than a touch of “déjà vu” in the financial markets at the moment.  Yet again we are faced with speculation about a country (Greece) leaving the eurozone.  Once more we are looking ahead to what seems likely to be a year of very weak growth and inflation in the eurozone.  And of course we are again waiting to see what the ECB will do when it finally makes its mind up about how to react to these various issues.  In our view the markets are correct to be worried about these problems – they are very real – but it remains more likely than not that the outcome will also be the same as in previous years – a “muddle through” with no dramatic progress towards better growth and inflation, but no collapse of the eurozone, no country leaving it, and no severe recession either.

Before explaining why we think the ‘muddle through’ scenario is the most likely, it is useful to take a look at recent developments as in some ways the situation that European authorities face now is as serious as anything seen at the height of the eurozone fiscal crisis in 2011/2012 – with the major difference being that financial market sentiment, so far, is dramatically more positive now than it was then.

Greek turmoil

Firstly, we focus on Greece.  As readers will be aware, the failure of the Greek parliament to elect a new President in three attempts last month forced the government to call early elections, in what was in effect a major victory for the opposition.  The leading party in all opinion polls is “Syriza”, a left-wing and relatively new party.  Until very recently it would also have been described as an ‘anti-European’ or ‘anti-euro’ party, and it can certainly still be called an anti-austerity party.  Syriza’s gains in popularity have been driven by the austerity policies implemented by the governing political parties, which policies in turn were largely forced on the government by the troika after Greece was the recipient of a large bail-out from the IMF, European Central Bank and other European governments. In practice those policies would have had to be implemented in any case but the troika has been blamed for the very severe cuts in spending that have been implemented during the crisis period.

Although Syriza is expected to win only about one-third of the votes, that share is expected to be significantly larger than any other party.  And, crucially, Greek electoral law gives a large ‘bonus’ allocation of seats to the largest party in the election, which means that Syriza is likely to have almost enough seats to form a government by itself. 

What makes all this so important is that Syriza has had policies that are very anti-establishment (for want of a better phrase).  It believes that the solution to Greece’s fiscal problems is for lenders to Greece to write off large amounts of the debt, and until recently at any rate Syriza has seemed to want Greece to leave the eurozone entirely.  It is adamantly opposed to the various austerity policies being implemented by the current government.  On the face of it, this is quite dramatic, particularly the desire to leave the eurozone.  If that still is the Syriza policy (more on this later), and if Syriza does win the election as expected, it would mark the first time that any eurozone country has been led by a party that supports exit from the eurozone. Even at the height of the eurozone fiscal crisis in 2011/2012, every eurozone government was adamantly and absolutely opposed to their country leaving the eurozone.

An exit from the eurozone would certainly be extremely messy – there are no provisions in European law to allow it, and it would involve the creation of an entirely new currency, as quickly as possible.  In all likelihood, the banking system or large parts of it would collapse and/or need huge taxpayer bailouts due to the mismatch between euro denominated liabilities and drachma (if that was the new currency’s name) denominated assets, and there would be a degree of chaos for some weeks in the interim period with a massive hit to economic activity in Greece.  Internationally, a Greek exit from the eurozone would surely bring more pressure on other peripheral countries in the zone, such as Portugal, Cyprus, Ireland, maybe even Italy and Spain, as if one country left the euro, others might be thought to be at risk of doing the same.  We would expect an extremely negative market reaction to such a development, one which might make the previous eurozone fiscal crisis look quite mild!

ECB grappling with difficult issues

Meanwhile, “back at the ranch”, the European Central Bank continues to struggle with dangerously low inflation and economic growth across the eurozone as a whole.  It seems reasonably clear that if inflation, in particular, falls further from here, the ECB will take more drastic actions to boost growth, inflation, and confidence.  The most likely option is that it will inject cash into the economy by buying government bonds, in the first half of the year, in effect printing the money with which to buy them.

However, the Greece situation is an unwanted complication for the ECB.  If Syriza wins power in Greece, it will put huge pressure on Greece’s creditors to write off all or part of its debts.  And the ECB happens to be a large creditor of Greece as it owns, directly or indirectly, a large quantity of Greek government bonds (Greek government bonds are no longer investment grade, so many private sector investors no longer buy them).  Thus the ECB is currently trying to reach a decision on whether to buy large quantities of government bonds, at exactly the same time as it is being asked (by Syriza) to accept large losses on the Greek government bonds that it already owns.  That is a complication that the ECB – and all of us in the eurozone, perhaps – could really do without, and that might well prevent or substantially delay the introduction of further ECB measures to help the eurozone economy.

Muddle through still the most likely outcome

However, we should not get too carried away by all the seemingly bad news.  As we stated at the outset, we do NOT expect the situation to deteriorate very rapidly in the months or weeks ahead, notwithstanding the sometimes grim-looking outlook. There are a number of factors which will combine to make another year of “muddle through” more likely than a year of crisis:

  • In Greece, Syriza has significantly toned down its anti-European rhetoric in recent months. Most likely this is reaction to the realisation that it may very well soon be in power, and will have to make difficult choices in government.  It would not be the first opposition party, in any country, to become much more pragmatic once in power (or getting very close to it) than it was in opposition.  Now the party says that it is now not in favour of a Greek exit from the euro, assuming that a debt relief deal can be done, which appears to be a marked change in policy.
  • More than 70% of Greeks, in a recent opinion poll, want to remain in the eurozone, notwithstanding the tough austerity policies that have been perceived as being imposed by eurozone, and especially German, political leaders.
  • While Syriza is the leading party in all opinion polls, it is still getting only about a one-third share of support in those polls – far from an overwhelming mandate to discard conventional economic policies and/or exit from the eurozone.
  • At the ECB, although the financial markets are impatient with the pace of the ECB’s reaction to negative economic news, it seems fairly clear that the ECB will significantly step up the pace of liquidity creation (printing money) this year, and probably sooner rather than later.  Certainly it is undoubtedly unhelpful that the ECB may be forced into taking losses on its holding of Greek government bonds, at almost the same time that it may begin buying government bonds on a large scale.  But what choice does the ECB really have?  If it does not ‘step up to the plate’, there is a very substantial risk that inflation will fall into negative territory, and remain there, dragging economic growth down after it.  The only way that we can see the ECB not becoming much more radical in liquidity creation is if economic growth and inflation turns out to be much better than expected.

Our conclusion, therefore, is that 2015 will be a year of (even) greater volatility – and action - in the eurozone than was 2014, in terms of politics and policy. But as has been the case for several years now, the authorities will do enough to prevent that volatility and uncertainty translating into a full-blown crisis.  In the next couple of days, Noel O’Halloran, our Chief Investment Officer, will publish a separate blog outlining what this scenario means for asset allocation in 2015.

Eoin Fahy, Chief Economist, Investment Strategist

 Since the current global bull market began during the first quarter of 2009 there has beenconstant debate between bulls and bears about whether the markets are being driven by strengthening fundamentals or driven by free and abundant liquidity provided by central banks led by the US Federal Reserve. We have maintained a consistent view that the bull market has been driven by a combination of both liquidity and improving fundamentals. Markets themselves can be swayed by the additional ingredient of investor sentiment and as we know in relatively short time periods, investors can move from unbridled optimism to wholesale pessimism in a herd like manner. At present they appear to be veering towards the pessimistic side.

From our perspective while headwinds and challenges remain, the key factor we focus on is the economic outlook. We do not see a material change to the fundamental economic and market outlook we have been writing about now for the past number of quarters. A fundamental part of our thesis remains as written last quarter where we highlighted the slow return to "normalisation", with the nature of this economic recovery remaining similar to none other i.e. being particularly 'sub-par' as we work through the excesses that caused the last downturn. 

Central bank actions will be consistent with how they see their own specific economic area, but in a global interconnected world economy their impact is not isolated to their region. Indeed the more positive outlook for the US economy versus Eurozone has already been reflected in the rapid weakening of the euro so the markets are already doing some of the central bank’s work for them. Concerns about the Federal Reserve tightening are overdone and in particular by those with inflationary worries in mind. While there are reasons to worry about potential deflation in Europe there is not a corresponding argument to be over concerned about inflation in the US economy. In fact far from worrying about the removal of liquidity support from global markets, we believe that central banks need to keep interest rates at what will be viewed in history as emergency levels as this is what the 'sub-par' recovery necessitates.

Geopolitical events remain constants in the world of investing with the frequency and scale of events oscillating quarter to quarter. As an investor it is best analysed in terms of whether any economic impact is adequately modelled in economists’ forecasts and whether the risk is appropriately embedded in asset class valuations. At current levels, we believe equity markets to be again fairly valued and in line with historic averages with subsequent returns from here going to be strongly influenced by earnings and dividend growth rather than banking on higher valuations. The greater volatility and polarisation within market performance over recent months provides some very attractive investment opportunities for stocks or sectors that look to be overly punished by investors. 

Noel O' Halloran, Chief Investment Officer, Kleinwort Benson Investors

Kleinwort Benson Investors are pleased to announce that we have moved to a new city centre location. Our new headquarters are located at

3rd Floor, 2 Harbourmaster Place, IFSC, Dublin 1, Ireland.

The only change has been our postal address, all our telephone numbers remain the same. Please update your records and send all correspondence to the above address.

We are very excited about this move and, as always we remain committed to providing excellent client service, while continuing to focus on delivering strong performance for our clients.

In my beginning of the year piece, I expected 2014 to be another positive year for markets. As the first half draws to a close it has indeed turned out to be a positive period, with equities up 5.6%, bonds up 4.5% and commodities up 0.8% during Q2, which took the returns for the first half of the year to 6.9%, 10.5% and 7.8% for equities bonds and commodities respectively.[i] Many of the positive tailwinds that helped markets during 2013 prevailed in the first half of this year as well, with 2013 laggard assets such as Emerging Markets, commodities and Agribusiness related equities performing admirably.

As I ponder the outlook for the second half of the year, my fundamental position has not changed and I do expect further market gains, notwithstanding an acknowledgement that with equity markets at new highs and bond yields remaining at record lows, some form of tactical setback in markets does feel overdue. The constructive outlook remains supported by some strong underlying themes:

  1. Slow return to "normalisation". The nature of this economic recovery remains similar to no other and is particularly 'sub-par' as we work through the excesses that caused the last downturn.  While not exciting from a growth perspective, from a markets perspective it leaves us with an attractive cocktail of lower-for-longer interest rates, continued low inflation, helpful central bank policies and at the same time growth that - while tepid - is leading to earnings and dividend growth that helps propel equities forward. This theme I believe has a few years left to run before the global economy gets back to its historic trend levels.
  2. Corporate usage of cash. While headline writers have obsessed on high levels of government and consumer debt, we are also focusing on the opportunity provided by record levels of cash on the balance sheets of many of the companies in which we invest. As corporate confidence improves we are increasingly seeing company management deploy this cash. Favourites to date have been to increase dividends and share buybacks (both of which are key drivers we capture in our Global Equity Strategies) as well as more judicial spending on overdue capital expenditures or hiring of new employees. A more recent phenomenon and a sign of increased confidence has been the increase in corporate takeover activity. This merger and acquisition theme will only increase in momentum from here and will be bullish for markets.
  3. Fundamentals versus liquidity! While some have argued that the bull market has been liquidity-driven rather than driven by fundamentals such as improved corporate earnings, I disagree and say it is a combination of the two. As we move towards 'normalisation', central bank liquidity will and should wane and fundamentals will become more the primary driver. I remain confident that we will see high single digit earnings growth for global equities this year, which is not inconsistent with the type of overall high single digit/low double digit equity returns that I believe it is appropriate to expect.
  4. From a sentiment perspective, despite record highs I see no evidence of exuberance or investor actions that would historically be associated with market peaks. For example, in terms of investment styles, high momentum sectors aren't persistently outperforming nor do I see any massive valuation concerns in sectors of the markets. The IPO market is still relatively subdued and finally I see little evidence of retail investors returning to equity markets to any great extent and in fact remaining generally cautious.

What will drive markets from here?

  • The continued growth of the global economy and corporate earnings
  • A continued improvement in corporate and consumer confidence
  • Investor flows should improve further as investor confidence increases and they increasingly dislike the alternatives.

What could derail markets from here?

The list is relatively short but global geopolitics is clearly a concern and something we are actively monitoring. In terms of valuations, I note that equities are no longer cheap on a standalone basis and are now at a small premium to their historic average. This is new but equally I am not concerned at this point as they remain well within historic ranges and when compared to asset classes such as bonds or cash, they still look particularly attractive.

Finally, a turn in the interest rate cycle is a potential problem. We have already seen heavy hints from the Bank of England that rate increases might come earlier than the markets expect.  As the months go by, I do expect similar comments from the more important US Federal Reserve. Rising rate worries could derail markets at some point, but I would however still believe that it will be a couple of years before we will see aggressive rate rises.

To conclude, the first half of the year has been positive and despite new highs on markets, I believe the outlook remains bright. As always there are headwinds and surprises that lie around the corner. As active managers our portfolio managers here at Kleinwort Benson Investors remain alert to opportunities as well as to threats. The environment for active stock picking remains fertile and we continue to focus on companies with strong fundamentals, attractive cash flows and a strong mindset towards shareholder return.

Noel O’Halloran, Chief Investment Officer


[i] Equity return quoted is the MSCI equity world index return, the bond return is the return on the ML over 5 year eurozone government bond index, and the commodity return is based on the DJUBS Commodity index, all in euro terms.

The results of the European Parliament elections have received a great deal of media – and financial market – attention.  Far-left and far-right political parties made strong gains in several countries, and those parties were in many cases in favour of their country withdrawing from the European Union and/or leaving the eurozone.  However, in other countries the results were very different, and we conclude that in reality little has changed and there is little chance of significant changes to key economic policies, or of “political gridlock” at European level.

The headlines this week have been fairly stark.  Anti-European or ‘extremist’ political parties performed exceptionally well in the European elections across the continent.  The National Front, the UK Independence Party and Syriza topped the polls in France, the UK and Greece respectively.  Voters have shown their disillusionment with Europe and their resistance to “austerity” policies.  Europe is in near-crisis with eurosceptics forming a powerful bloc in the European Parliament. And so on.

But here are some alternative headlines that you probably did NOT read this week, but which are also true:

  • Pro-European governing party in Italy makes huge gains and comfortably tops the poll.  Gets best ever result for any party in European elections.
  • Anti-European party in Germany wins just 7% of the vote
  • Hard-left Syriza party in Greece underperforms expectations, does not do enough to bring down the government.  Junior governing party outperforms expectations.
  • Centre-left and centre-right moderate bloc holds huge majority in European parliament (469 seats vs 178 for the Greens, Conservatives, Left and far-right Eurosceptics combined).
  • Governing party tops the poll in Spain. Protest party wins just 8%.
  • Far-right vote in the Netherlands well below expectations.  Takes third place with 13% of the vote.

So it's best, of course, to look at the whole story.  Yes the euroseceptic/anti-austerity/protest parties did well in some countries. But they did quite poorly in others.  In no country were the results so dramatic that the government is at risk (with the possible exception of Ireland if the Labour Party were to withdraw from government after it elects a new leader).  And the centrist, moderate bloc of parties still has a very comfortable majority in the European Parliament (which anyway has quite limited powers as most key decisions in Europe are still made by European governments, often by consensus).

In assessing the outlook for European equities and government bonds, therefore, we will continue to focus on the prospects for economic growth, for monetary policy and for corporate earnings growth, all of which are more significant in our view than the 'noise' from the European elections.Indeed it was interesting to note that despite the blizzard of news, much of it seemingly negative, the financial markets largely ignored the elections.  The European stock market rose by more than 1% on Monday, and the euro strengthened marginally.

Valuations remain reasonable for equities (though bonds are expensive, as are most developed market government bonds), there is unlikely to be a significant change for the worse in economic policies, and there is no sign of a return to the crisis days of a couple of years when some commentators expected the eurozone to fall apart.  Gridlock in the European Parliament is very unlikely, and even if it happens, the US has managed quite well for the last couple of years despite complete gridlock in Congress!



In the first quarter of 2014, investors were ‘hit’ by a barrage of macro challenges in the US, China and Eastern Europe, and investors also fretted about whether Japan and Europe were gaining the upper hand in the battle against deflationary challenges. In the US, very severe winter weather was the presumed cause of a significant decline in economic activity.  In China, the economy slowed sharply- leading to expectations of a government stimulus package – and to cap it all the crisis in Ukraine raised geopolitical tensions across Eastern Europe and beyond.

Despite these ‘hits’, global equity market performance proved to be very resilient with the world equity index rising by 1% in local currency.  Europe led the way, with the eurozone index rising 2.8%, slightly ahead of North America, which rose 2%.  Japan was the laggard, showing a decline of 7.5%, while Emerging Markets were down very slightly (all returns in local currency).  In contrast, bond markets (in Europe in particular) appeared to benefit from falling inflation and improved sentiment towards peripheral countries,  and delivered strong gains as the European over 5-year bond index rose by almost 6%.  Commodities were very strong, rising by about 7%, regaining some of their losses in previous quarters.

Hits perceived as transient

It’s very clear, therefore, that markets regarded these ‘hits’ as transient and focussed instead on improved long-term fundamentals.  That is not particularly surprising given that I believe that the current global economic recovery has at least another three years of growth before we concern ourselves about the next economic downturn. The continued slow but steady global economic recovery will prove resilient and continue to demonstrate recovery. I reiterate my strongly held conviction that real assets such as equities and other alternative asset classes are attractive for as long as  global central banks are fighting deflation and downside risks to economic growth. While in the short term such actions also help bond yields, in time recovery will prove a big negative for bonds.

In January, I expected 2014 to be another positive year, with a likely outcome of high single/low double digit returns from global equity markets. This would be consistent with expected global earnings growth for 2014. Equity markets are no longer cheap and are generally now trading at long term average valuations. Therefore, my central expectation was and remains  that returns will be consistent with earnings growth from here out rather than further expanding valuation multiples – though there remains some possibility that abundant liquidity could push valuations up still further. 

What we are watching

As we enter the second quarter there are a number of key fundamentals that we are watching:

  • A key factor will be the upcoming company earnings reporting season. While many US companies (cyclical ones in particular) will no doubt have been hit by adverse weather during the first quarter, their outlook, commentary and guidance for the remainder of 2014 will be very important to markets.
  • At a macro level it is crucial that the US economy does rebound from the weather affected first quarter. I certainly expect it to, having spent some time looking at this issue while in the US recently on a research trip.
  • A missing ingredient from this recovery has been any material sign of growth in corporate capital expenditure. We are at a stage in the economic cycle where many economists expect to see increased signs of such a pickup. This new dynamic would be a positive not just for economic growth but in particular for corporate earnings.
  • Although we have no official numbers yet for the first quarter economic growth in China, it does appear to have been particularly slow. I maintain the view that the economy will not have a hard landing and Premier Li has said several times in the last few weeks that he had means and ways to protect the economy from deterioration if necessary. A natural rebound in growth, or one helped by further stimulus measures by the government would be positive catalysts and further welcomed by markets.
  • For over 12 months now equity market performance has been polarised between strong developed market performance and struggling Emerging Market (EM) performance while EM battled with a number of headwinds. Over the remainder of 2014 I expect this trend to reverse and EM to gain positive traction again. This will have to be driven by a pick-up in both earnings and economic growth.
  • While a rising tide hasn’t to date seen any significant differentiation between US, Europe and Japan, I believe that there is a real chance that markets will challenge this more and focus on whether the latter two are truly synchronised with the US economic recovery or whether they are in fact struggling and deflationary forces are materially different for Europe and Japan than in the US. To date, markets have given them the strong benefit of the doubt but I note that the ECB for example has spent a lot of its recent press conferences discussing what tools they have at their disposal to fight deflation, if necessary.  If the economy is recovering, as the markets believe, why is inflation so exceptionally low?

Emerging Markets

It is worth expanding further on my views on Emerging Markets, as markets are very focussed on that topic.  As I stated above, I believe they will begin to converge again with Developed markets, and for those looking for a ray of hope, Emerging Markets had a significant outperformance over recent weeks. At a fundamental level while challenges remain (growth and politics) across various emerging markets, I believe we are well past the worst and that the key catalysts of economic growth and earnings growth  will help over coming quarters.

It’s important to note that investor sentiment and positioning is very poor towards EM. This is not at all unusual as historically investors either hate or love emerging markets with seemingly no in-between state! Any investor with a grain of contrarian instinct would be looking to buy EM and particularly as valuations are well below historic averages. This is also against a background where some argue that many investors are increasingly ‘in love’ with developed markets such as the US. At a fundamental level, although challenges remain, EM economies are in a much healthier state than they were ahead of the 1997 Asian crisis and I do have confidence that the Chinese will manage the rebalancing of their economy without a hard landing.

Investment markets remain as dynamic and challenging as ever. In this quick blog I have summarised some of the major drivers we will continue to focus on during the second quarter. Within markets and for your portfolios we are also managing both sector and style volatility. By style I mean whether for example value, growth, momentum or yield are performing best and we have noted more volatility in styles over recent months. Consistent with a slow but steady recovery in global economic growth we continue to believe that stock picking should remain concentrated on companies with strong balance sheets, positive earnings guidance and a strong attention to cash flow and dividend payments. The bottom line remains that I expect 2014 to be a solid if not unspectacular year of returns for investors despite the headline challenges.

Noel O’Halloran, Chief Investment Officer

Donore Harriers athlete John Travers has won the 2014 St. Patrick’s 5K Festival Road Race, which took place in Dublin on Sunday 16th March. He completed the course in a time of 00:14:07.

St.Patricks 5K winner Thumbnail0

Second place went to Colm Rooney from Clonliffe Harriers AC who finished in 00:14:23. He was followed in third place by Kevin Maunsell of Clonmel AC in a time of 00:14:43.

The women’s race was contested by two of the biggest names in Irish athletics with current star Fionnula Britton holding out against former London marathon winner Catherina McKiernan who made a rare competitive appearance for this event. Fionnula Britton completed the course in a time of 00:15:33 and Catherina McKiernan completed the course with a time of 00:15:58.

Fionnuala Britton is currently one of Ireland’s top athletes and was the gold medallist at the 2011 and 2012 European 2012 European Cross Country Championships and was the first woman to successfully defend this title. She has represented Ireland in the steeplechase at the 2008 Beijing Olympics, the 2009 World Championships in Athletics, and twice at the European Athletics Championships.

St.Patricks 5K women s winner Thumbnail0

Veteran athlete Catherina McKiernan is a double Olympian and  has won four silver medals at the World Cross Country Championship and gold at the European Cross Country Championship. She has had notable success at marathon having won at Berlin, Amsterdam and London and holds the Irish national record at the marathon distance which was set in 1998.

Third place went to Lifford AC athlete Ann-Marie McGlynn in 00:16:01. 

Organised by Metropolitan Harriers & St. Brigid’s Athletic Club, the race was a highlight of the annual St. Patrick’s Festival programme and a major element in attracting tourists and visitors to Dublin City. The record 1,700 entries were made up from dedicated athletes, families, tourists and fun runners alike.

St.Patricks 5K race start Thumbnail0
Praising the efforts of all who took part, race director Eamonn Coghlan thanked Dublin City Council and An Garda Síochána for the support which they had given to the event.
Sponsorship was provided by Kleinwort Benson Investors, specialist provider of niche investment strategies for pension funds, charities and corporate bodies, who have supported the event for a number of years. 

As an added attraction this year and to coincide with their forthcoming Muppets Most Wanted movie, Disney held a competition for the ‘best inspired Muppet costume’ in the race which was won by 11 year old MSB AC athlete Sarah O’Gorman from Castleknock whose prize is a private screening with 100 of her friends!

Having remained optimistic throughout 2013, I believe that 2014 will continue where 2013 left off and at this point am not advocating any changes to the “positive positioning” we have in place for discretionary client portfolios. I expect 2014 to be another positive year for global equities with bond markets once again struggling. Equity valuations are no longer cheap but equally they are very far indeed from what would be considered ‘bubble-like’.KBI078 white Thumbnail0

We are now over five years on from the worst of the global financial crisis and the global economy is moving from the post-bubble phase to a phase of ‘self-sustaining normal growth’. I expect all of the large developed economies to grow more strongly in 2014 than they did in 2013.  The improvement is likely to be strongest in Europe, with the economy returning to positive growth this year.  The picture is slightly different in Emerging Market economies, where growth has been reasonably strong for some years, but has faded somewhat in recent months.

Equity markets have of course correctly anticipated this improvement, with strong returns in 2013.  The likelihood for 2014 is that equity markets will match earnings growth (rather than exceed it), producing positive but more modest returns than 2013.  In contrast, the outlook for bond markets is negative, as central banks, and particularly the US Federal Reserve, move away from their policy of massive liquidity creation. Alternative asset classes such as commodities had a less positive 2013 but I suspect they will be more competitive in a diversified portfolio this year. I am all too aware that these optimistic views are much more consensus today than they were 12 months ago and the degree of bullishness amongst investors is increasingly high, which has historically been an uncomfortable place to be!

I have no doubt that there will be challenges to markets as the year unfolds and in this blog I will focus on the key risks – both upside and downside! – to markets this year.

The following are scenarios or risks we consider in descending order of likelihood for 2014:

 Risk 1: Economic growth turns out to be much stronger than expected:

Such an outcome would certainly be a major negative for bond markets and would exert more of a two-way pull on equity markets which could lead to a flattish out-turn for equities. We witnessed such an environment in 1994 where stronger than expected economic and earnings growth were offset by sharply rising interest rates. In this scenario much will be written about central banks being ‘behind the curve’ as bond markets create headlines of an ‘inflation scare’. 

Risk 2: Equity market valuations reach expensive levels

In this scenario, ‘easy money’ from global central banks continues to be funnelled into equity markets and other risk assets rather than into the real economy (which itself doesn’t accelerate as expected but rather continues to muddle along).  Just as in 2013, equities deliver acceptable earnings and dividend growth but are turbo-charged by a further expansion of P/E multiples into expensive territory leading to a stellar 20-30% equity year.

Risk 3: Emerging Markets materially disappoint

In this scenario the struggle of 2013 would turn into a meaningful ‘actual’ issue, such as materially slower than expected growth in the Chinese economy or an unexpectedly negative market reaction to ‘tapering’ (incidentally, I believe that to have been last year’s story). While the coincidence of a material slowdown in emerging economies occurring at the same time as developed economies are accelerating would be very rare, it would be very messy for equities and positive for developed market bonds.

Risk 4: Europe IS the new Japan

Recent nascent optimism about a genuine recovery in European economy quickly fades as the green shoots of growth wither and die. ‘Japanification’ of Europe becomes the jargon phrase of the year (replacing ‘tapering’!).  The ECB again becomes the focus of attention and the euro weakens materially. Peripheral Eurozone bond markets also become vulnerable as core defensive bond markets come back into favour.

Risk 5: A year of 2 or maybe 4 halves!

Some combination of some or all of the above could occur leading us to expect a very dynamic roller-coaster type year. We have been there before!

Summary: 2014 similar to 2013

I expect that 2014 will most likely be a similar but less spectacular year to 2013 echoing many similar trends with the strong exception that I believe Emerging Markets will perform much better in 2014. Valuations (in Developed equity markets) are no longer cheap but I remain confident that earnings and in particular dividend growth will be even more important in this year than they were in 2013.    Risks abound of course – both upside and downside – as I’ve outlined above but the bottom line is that I expect that investors will reap solid – if unspectacular – gains from equity markets this year.


Noel O'Halloran, Chief Investment Officer

As Ireland exits its three year troika bailout period, it is a good time to ‘take stock’ of the deficit and debt situation for the country. How big is our debt relative to history and to other countries? How much work needs to be done to get the budget to balance again? Do recent good economic data (rising employment, falling unemployment, etc) make a big difference to our fiscal situation?

Let’s start by looking at the national debt. The bad news is that of course it is at a very high level, about 124% of GDP. That’s about €45,000 of debt for every man, woman and child in the country. By way of international comparison, as the chart below shows, it’s the fourth highest in the EU, after Greece (170%), Portugal (132%) and Italy (134%). debt to gdp

The good news (though it that much to shout about) is that this year should mark the peak, and on reasonable economic forecasts the debt should be down to about 114% by the end of 2016, as this chart shows (using Department of Finance projections).

debt to gdp over time

Next, let’s look at the deficit, the gap between what the government takes in and what it spends. This year that deficit will be about 7% of GDP, or €11.5bn. That compares to a peak – excluding the money needed for bank rescues – of 11.4% in 2009. Ultimately the budget needs to balance, of course, but first the deficit needs to at least fall to 3% of GDP as that is the highest level accepted by the EU under its fiscal rules.

defict as pct gdp

So the bad news is that – at first glance - we are only about half way from the worst point (11.4%) to where we need to be (3% at max). But that perhaps understates the extent of progress, as the economy has now begun to grow. And it is economic growth, above anything, that will get the deficit down. We expect that that growth, combined with some relatively modest spending cuts and tax increases in the 2015 Budget, will drive the deficit down to below 5% next year, and to below 3% in 2015.  In fact the graphic below (from the NTMA) shows that the vast bulk of budgetary consolidation (or austerity measures, if you prefer) is already complete.  To be exact, of the 20% of GDP of budget measures that are due to be done between 2008 and 2015, 18.9% has already been done.austerity so far

So a stock-take of Ireland’s fiscal situation shows a mixed picture. The deficit has already come down substantially and the pace of decline will accelerate from here. That is vitally important as once the deficit is eliminated, or reduced to an acceptably low level, austerity measures will no longer be required.

But on the other hand the outstanding stock of national debt that has built up as a result of the huge deficits of the last few years, and the need to rescue the banks, remains very high and will only begin to decline slowly from next year. Ireland will need to continue to run very cautious fiscal policies for as long as that stock of debt – and the interest burden on it –remains at high levels.Austerity measures may be coming to an end - but Ireland is a very long way from being in a position to begin to substantially increase public spending or cut taxes.


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© 2015 Kleinwort Benson Investors Dublin Ltd


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