The investment lessons from 2013

Coming into the Christmas season, and before I get out the crystal ball to gaze into 2014, I want quickly take a look at the key lesson of 2013.

There were some critical developments, which we must keep in mind when thinking about the investment landscape. The distinction between perception and reality is one.

At the beginning of 2013, the grave concern was the United States fiscal cliff. It was argued by the Congressional Budget Office and people like US economist Paul Krugman that a recession could ensue. Here is what Krugman said on the issue to the PBS Newshour:

“We're going to have substantial spending cuts, substantial tax increases at a time when the economy is still very weak. And, of course, that's a recipe for sliding back into recession.”

The ‘cliff’ turned into the ‘sequester’ – a milder cliff that was supposed to knock 0.6 percentage points from GDP and knock off 750,000 jobs. The fear was the same though – a weak economy. A year or so on, and for all the discussion, none of it had a discernable economic impact – as I argued would be the case at the time. (See Don’t fall over the fiscal cliff and The slowdown lowdown: No cause for alarm.

Perception versus reality. I bring it up, because it highlights a key fact for 2013, one of the most important lessons, given away by the title below.

Global growth is on a much stronger footing than the consensus suggests

The fact is, 2013 wasn’t a bad year for investors at all. Property prices rebounded around the globe, global share benchmarks hit new records, and even the Australian market belatedly joined the global equity bull run. Gains in some cases were spectacular – and all in all we should be wealthier now than we were 12 months ago. Once again then, for something like the fifth year running, the downside risks were exaggerated and the pessimism was overdone.

2013 was the year the ‘three track CD’ finally stopped playing

For the better part of the last five years global markets have had to deal with the following potential threats– a Eurozone implosion, a US double dip or downturn, or a China hard landing. This time last year we learned that the Eurozone would in fact not implode – the crisis was over. A few months ago we learned that far from China having a hard landing, the economy actually accelerated. (See Crunching China’s credit crunch fears and Don’t fear a China crisis.) Similarly for the US, jobs growth accelerated and economic growth overall looks to be picking up to an above trend pace.

We shouldn’t underestimate the potential impact the US budget deal will have. That three track CD has effectively been the only headwind hitting investors. Think about every time we’ve had a correction – one of those songs was playing loud. Then think about what happened when the Eurozone implosion song stopped. I said at that time it was a critical turning point – a game changer, and it was. Global benchmarks shot to new records – the S&P 500 nearly doubled its gain of the previous year to rise 24% so far. Moreover, while the annual growth rate of our market so far isn’t great at 9.5% vs. 13.5% last year, 2013 is the year the All Ords broke out of its three to four-year trading range.

…global corrections are shorter and not as sharp

In 2012 there were two sizeable downside moves on the S&P 500 – of about 10% over three months in the first half of 2012, and then again at the end of the year (about 7%). In 2013, the largest correction on the S&P 500 was mid-year when the market lost about 5% over a month. Another way of thinking about is that volatility has declined substantially, and I think one of the key implications of the end of the three track CD is that volatility may be even lower in 2014.

The investment landscape has changed – we won’t see a repeat of 2007-08 soon

Having said that, I think this market boom will be very different to the one we saw in 2007. I got my global growth story right, against the consensus, but one of the key material changes to my view over 2013 was on the outlook for inflation. Don’t get me wrong, we got inflation – not disinflation or deflation. That was the right call, and we are seeing it most clearly in asset prices. But my thesis was always that the nexus between rising asset prices and consumer price inflation would be commodities. And that link has been severed.

Policy makers, not a fragile recovery, are the main source of market uncertainty

That’s still leaves policy makers – central banks, parliamentarians and regulators – as the key source of volatility for the market though. Whether it’s the taper, austerity, budget deals or what have you, the biggest swings or pick-up in volatility usually stems from their comments or actions.

Australia is very different – consumers are the key

While my global economic call proved to be correct in 2013, the domestic economy, in contrast, is softer than it should be. On paper we should be booming – all the planets are aligned, as I noted in 2012. Instead we have sub-trend growth. To be fair though, I did acknowledge that the single biggest threat to my view would be confidence - and that’s exactly what happened.  Consider that this sub-trend growth hasn’t’ followed the official script.

Recall that policy makers had been concerned the end of the mining boom would be the causal factor behind sub-trend growth. Instead, Australian Bureau of Statistics data shows that sub-trend growth is instead due to a sudden slump in consumer spending – and this occurred because consumers became fearful after all the talk of a mining bubble bursting induced recession (see my piece Can Australia avoid a confidence death spiral?). Consumer spending, or its growth rate, has halved since 2012, from what it was in 2010 and 2011 despite the cash rate being slashed. This isn’t something that is discussed by economists, policy makers, or anyone really – it’s simply ignored. Too much time is spent discussing the end of something that hasn’t ended – instead the real issue is the outlook for the consumer.

As a result of ‘end of mining boom fears’, overlaid with China hard landing fears, the Aussie market has been more volatile than its global peers. Corrections in the Aussie market were much more pronounced and our biggest peak to trough move was 11%; so far we’ve seen another 7% correction since October.

Aussie stocks joined the global rally, but momentum is lukewarm

Not only is our market more volatile, investors seem only to have a lukewarm regard for our stocks. That may sound odd when the top 10 performing stocks in the ASX 100 were up between 40% and 75% so far. But you’ll get an idea of what I mean when you look at the stocks in that top 10.

Investors seem to be picking unloved, unnoticed or ‘recovery’ stories. And when I say recovery I mean a recovery from the depths of despair – from an oversold position. I’d put steelmakers, like BlueScope Steel and Arrium in that position, as well as Harvey Norman. These stocks have rallied hard but that’s not because they are performing well or are ‘strong buys’. It’s not a case of picking the winners here. They’re just not as bad as feared, or there is some glimmer of hope – earnings performance is still poor, but because the worst didn’t happen or is over, they’re correcting. And, in an otherwise expensive market, momentum counts.

It’s a similar story for diversified financials like Challenger, or banks like Bank of Queensland. This is not a bull market signal. This is not the exuberance, irrational or otherwise, that we are seeing around the globe. When I think about global equities in general terms, it seems investors in overseas market seem to be investing for growth – in Australia, it still very much a value mentality.

That’s a general observation of the market, I know it’s not true in every case. CBA, for instance, (see my piece Carr’s Call: Don’t buy the CBA sell story. To that I’d add stocks like NAB, Brambles and JB Hi Fi, which was my key retail pick this year – up 90% (see my piece Carr’s Call: Retailers losing bargain appeal).

However that, and other ‘winning’ stocks aside, 2013 taught us that despite what is going on globally, we must remain very cautious on the Aussie market and invest globally (See my piece Make a Europe splash with Aussie cash and Carr’s Call: Go offshore for better upside). Australian pessimism is entrenched, business is not investing and this has driven our sharemarket’s underperformance. Global investors remain scared off and are reluctant to embrace our big miners. Lower rates don’t seem to be helping.

Conclusion

2013 was a great year for investors, and there were some very positive developments through the year such as stronger growth, lower inflation and, in particular, the end of the three track CD. The Australian market has been, and will likely remain, more volatile. It’s harder here, as investors have not embraced the Australian growth story.