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Interest rates and inflation are key

Despite the doom and gloom of the financial crisis, global wealth has more than doubled since 2000, reaching an all-time high of £145 trillion last year, according to the Credit Suisse Wealth Report.

In addition, the Capgemini and RBC Wealth Management 2013 World Wealth Report shows that one million new high-net-worth individuals (HNWIs) were created in 2012. Altogether, the 12 million HNWIs saw their value grow by 10 per cent in 2012 and this means there is more wealth that requires careful management.

Emerging markets have become the global engines of growth, but some have recently gone off the boil. For example, Brazil generated only 2.1 per cent gross domestic product growth in 2013 and Russia 2.4 per cent.

China’s 6.9 per cent growth was lower than expected and investors are concerned about the country’s project to dismantle its shadow financing structures, which distorts market-pricing mechanisms and drastically reduces transparency.

These reforms may have a performance drag on the economy because bad assets are identified and isolated – as they have been in developed economies in “bad banks” – but they are an essential part of the next stage of the economy’s development.

China isn’t alone, as many others, including India, Brazil and Indonesia, are under scrutiny to restructure their economies.

It is the United States that is driving the world economy and analysts anticipate growth of something like 2.9 per cent in 2014 with more to come. There is also something of a “great rotation” happening, not just out of fixed income into equities, but from emerging to developed markets.

Emerging-market funds peaked at flows of US$360 billion in 2013, but that figure now stands at $260 billion, says Eric Verleyen, group chief investment officer at SG Hambros.

“[The money’s] not sticky and, as we enter a period where interest rates in the US might rise, there are some good opportunities for investors to close positions in emerging markets, due to volatility, and move assets to developed markets,” he says.

We are on the cusp of a wave of corporate activity where spending will increase significantly

Equity markets will deliver lower returns with nothing like the benign levels of volatility experienced in 2013. Despite this, Jim Solloway, senior portfolio strategist at SEI, says the equity markets will see considerable inflows in 2014.

“The US had the best recovery and valuations have moved higher,” says Mr Solloway. “Though they haven’t reached ‘nosebleed’ level, and inflation remains low, we are not on the precipice of a bear market.”

Europe is also attractive, but as UK equities are “fairly valued”, he sees better opportunities elsewhere, but not just anywhere, he warns. “Europe is cheaper, but for a reason. Growth is not as dynamic, nor is it likely to become more dynamic,” says Mr Solloway.

He is concerned that the optimism of consumers and investors isn’t borne out by bank data which remains weak. “Bank lending remains very weak and the hard economic data, such as industrial production and retail sales, are still poor,” he adds.

That said, the equities bull cycle is set to continue as government policy is more “equity friendly”, says Mr Solloway, who remains unconvinced about fixed-income markets for 2014.

Central banks will continue to hold interest rates low until there are significant signs of growth. But that doesn’t mean ignoring the fixed-income markets, says Iain Tate, head of London & Capital’s private investment office.

“Pockets of credit remain positive and if you manage durations tightly, that is don’t take too much interest rate risk, you could do well,” he says.

Real estate has seen record inflows, especially the UK in 2013. Cesar Perez, chief investment strategist at J.P. Morgan Private Bank, favours property, provided it is the right market, but like many institutional investors seeking higher yields, is prepared to move up the risk curve.

“We like to access real estate through liquid markets, such as France, Germany and the UK, where there are opportunities in secondary locations,” says Mr Perez.

Lower returns with greater volatility will require more tactical work, he says, and investors will want to see earnings growth. Those businesses that survived the recession have been stockpiling cash and we are on the cusp of a wave of corporate activity where spending will increase significantly.

But investors won’t be happy to witness mergers and acquisitions without this adding to the bottom line, says James Horniman at James Hambro & Partners.

“Investors need to look at the relative return of cash, bonds and equities, and know they will be rewarded for taking risk, because volatility will be higher this year,” he says.

One thing is certain – nothing is going to be easy for investors in 2014. Those who seek security will have to pay a premium, while those with more appetite for risk will insist on being rewarded. Mr Perez puts it simply: “2014 is going to be the ‘show me the money’ year.”

As to where the nasty surprises lie, views differ. Overconfidence in certain markets is certain to develop if there are green shoots of recovery and it is human nature to want to believe the worst is over.

But the experts have an eye on interest rates and inflation. Either of these rising sooner than expected will result in policy changes that may have a profound effect upon recovering markets.