Growth expected in 2014: Russell.

Russell Investments is forecasting modest gains for equity markets and higher bond yields in 2014 following growth in major world economies, according to capital markets research released by the global asset manager.

The fourth quarter Strategist Outlook & Barometer report offers in-depth analysis of key economic and market indicators, with the insights helping to guide the firm’s multi-asset portfolios and services.

In the report, Russell cited politics – including uncertainty about U.S. monetary policy and political pressures globally – as the biggest threats to performance across asset classes in 2014.

Russell continues to favour equities over fixed income, with strategists remaining moderately positive on equity markets globally.

Domestically, Australian large cap equities have outperformed Australian fixed income by 23% (total return basis) over the past 12 months. According to Russell Investments’ Senior Investment Strategist for Asia-Pacific, Graham Harman, this pattern is expected to hold over the next 12 months, albeit at declining strength, as lackluster conditions and mixed economic signals affect Australian markets.

“We expect the low interest rates driving house prices to be balanced by a slowing domestic economy in the wake of a resource-sector boom,” he said.

The report also shows European equities are favoured over U.S. equities, while emerging market equities look increasingly more positive, possibly offering double-digit earnings growth in 2014.

Global Head of Investment Strategy at Russell Investments, Andrew Pease, said the forecast is for synchronised growth across the US, Japan and Europe for the first time since 2010.

“Looking ahead to 2014, we expect to see a strengthening low-inflation recovery that favours equities over bonds, despite relatively full equity market valuations,” he said.

Regional optimism in the Eurozone and Asia-Pacific despite political concerns

While Eurozone equities still appear relatively cheap and capital continues to flow amid the easy monetary policy of the European Central Bank (ECB), Russell’s strategists argue vigilance is still warranted. However, since the Eurozone’s key long-term problems have not been solved, these positives only marginally outweigh the negatives.

In the Asia-Pacific region, the investment climate continues to improve in Japan as Prime Minister, Shinzo Abe, appears successful in turning the economy around. Though stimulus and spending challenges remain, real GDP is at 4%, and monetary growth is at 3% year-on-year at the end of the third quarter, after bottoming near zero at the beginning of 2013.

Elsewhere, China’s economic rebalancing is performing as it should, and the Asia-Pacific region as a whole appears poised to respond positively to acceleration in the U.S. and/or European growth in 2014.

Asset class views

Russell’s global strategy team has a moderately positive view on global equity markets, while bond yields have fallen sharply in response to the Federal Reserve’s decision not to wind back their bond buying program earlier, a move that Russell believes may be an overreaction. Within regional equities, Russell prefers European and Japanese equities, followed by South-East Asia, the U.S. and Australia.

Mr Harman said emerging markets could get a renewed shakeout when talk of Federal Reserve tapering resumes, but believes most currency adjustment has already occurred across the vulnerable economies.

“Looking at the path ahead, we believe additional volatility may continue, but this could be leveraged as an opportunity to increase tactical equity positions, such as within multi-asset portfolios,” he said.

For more information, visit  the “Strategists’ Outlook and Barometer” report.

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Addressing clients at the Russell Investments Australian Investment Summit in Sydney today, Russell’s Chief Market Strategist, North America, Dr Stephen Wood said investors would be constrained by what he called the “squeeze play” in the current low return environment.

“Given that only positive real returns build wealth, investors are going to be confronted by the question of where to invest in a yield-starved world? This “squeeze play” pushes people into riskier assets, as the need for yield squeezes them out of traditional safe haven assets – such as bonds – which are likely to lock in negative real returns. Investors needed to guard against a knee jerk reaction into riskier assets that jeopardise their long term returns, and adopt a strategically disciplined approach,” Dr Wood said.

Drawing on findings from Russell’s most recent Strategists’ Outlook and Barometer, Dr Wood said in the longer term, Russell was viewing equity markets more favourably than fixed income, citing the U.S. Federal Reserve’s (the Fed) stated policy position to leave rates at current low levels until 2015.

“The Fed has said it won’t consider raising interest rates until the unemployment rate falls to 6.5%. Our projections agree with the Fed that this is unlikely to happen until 2015. We believe this will continue to constrain bond yields over the coming year, and this will be further exacerbated by deflationary pressures, as well as instability in Europe, which will drive investors to perceived safe havens,” Dr Wood said.

In trying to avoid the “squeeze play”, Dr Wood said it was important portfolios contained exposures to differentiated sources of return.

“Actively managed, globally diversified, multi-asset portfolios are the best shot investors have at avoiding this “squeeze play” between negative returns and riskier assets. Set and forget is not a strategy that will provide investors with the returns they need in what’s shaping up to be a low return environment,” Dr Wood said.

Russell communicates the changing role of bonds in multi-asset portfolios to clients

Last week, Russell announced changes to the fixed income component of its multi-asset portfolios. The changes have been influenced by market trends and the expansionary monetary policies adopted by central banks around the world, which have brought down short and long term interest rates.

With nominal yields at historic lows and credit spreads becoming compressed in many markets, Russell informed clients it was adapting portfolios in order to access new, diversified sources of returns and reduce the risk of capital losses, in the event rates rise and expose investors to higher levels of interest rate risk.

The new fixed income strategies added to Russell’s multi-asset funds include absolute return bond strategies and exposure to local currency emerging market debt securities. Both strategies offer lower volatility, diversification from developed market interest rate risk and attractive return prospects.

Senior strategist, Asia-Pacific, Graham Harman said: “With so much uncertainty in markets, it’s critical portfolios are appropriately positioned to weather a range of scenarios, while still maintaining diversified exposure to different sources of return.

“While we are favouring equities over fixed interest in the longer term, we believe there is still an important role for fixed income in diversifying portfolios. The skill for investors is in selecting strategies that will provide different types of return drivers, mitigitate any risks emerging and take advantage of market opportunities.”

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The Q2 Strategists’ Outlook and Barometer features in-depth analysis of key trends and indicators, and forecasts global equity markets to outperform global fixed income over the longer term.
 
Russell’s strategists hold a positive view of U.S. equity markets for the coming 12 months, despite economic growth projections remaining between 2% and 2.5% in the near term. Their two year view is also positive, however U.S. equity prices are expected to rise less rapidly as profit margins flatten.
 
Contributing to the optimism in U.S, and global markets generally, were the U.S. housing recovery, the cyclical rebound in China and Japan’s favourable policy initiatives. However, Russell’s strategists cautioned this optimism would be offset by ongoing volatility in the Eurozone, fiscal tightening and moderate economic growth in the U.S. over the next 12 months.
 
In terms of emerging markets, Russell’s strategists believe that despite underperforming developed markets during the recent rally, emerging markets are undervalued and demonstrate potential for double digit earnings per share growth in 2013.
 
Graham Harman, Russell’s Senior Investment Strategist – Asia Pacific, said of the local region: “Despite expected ongoing global volatility the major economies of the region – China, Japan and Australia – all have a positive outlook for the remainder of the year.
 
“China stands to benefit from its government’s commitment to infrastructure and expanding consumption base; while we expect Japan to receive a boost from export growth and increased competitiveness in general. As the resources sector slows, Australia’s two-speed economy will begin a transition into a one-speed economy, exhibiting a more steady growth outlook.”

Local fund managers expect share market run to continue to end of the year
The latest Russell Investment Manager Outlook (IMO) survey, shows local investment managers are continuing to favour growth assets in the continued search for yield.
 
The twice yearly survey which captures the views and insights of approximately 30 Australian fund managers, found just over 60% of managers expect the current run in the local share market to continue through to the end of 2013. The majority of these managers expected the primary driver of future returns to come from improved price-to-earnings ratios, or from a combination of earnings growth and higher share market valuations.
 
The survey found 80% of investment managers believe the Australian share market to be fairly valued, double that of the previous survey. Despite this, managers in the survey were less bullish on the outlook for Australian and international equities for the rest of the year.
 
Russell Director of Client Investment Strategies, Scott Fletcher, said overall, Russell’s team of strategists agreed with the views expressed by local managers in the survey. Relative to their own history, shares are at the top of the valuation range for the last four years since the global financial crisis, but short of pre-crisis valuation norms.
 
“Managers are continuing to favour equities over more defensive assets, and we believe that relative to bonds, shares still compare well. However, with the local share markets beginning to push past fair value after the double digit returns of 2012, we expect more modest performance for the rest of the year,” Mr Fletcher said.
 
Continuing a trend from the September 2012 survey, more than 70% of managers were bearish on Australian bonds, with the remainder maintaining a neutral sentiment. Other asset classes out of favour with managers in this survey included A-REITs, cash, and the Australian dollar.
 
“The results of this survey indicate fund managers are seeing the greatest investment opportunities in equity markets both at home and overseas. The views expressed by Russell’s own strategists indicate there’s still a great deal of uncertainty in most markets, but it will be critical that portfolios are constructed with the flexibility to capture opportunities as they arise,” Mr Fletcher said.

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