To butcher a paraphrase, 2014 was neither the best of years nor the worst of years. Whilst that sounds rather boring, a look at what went on reveals another year that kept the experts guessing and yet again confirmed the smartest thing long-term investors can do is to ignore those experts.
Here are some of the more noteworthy events for the year:
Bonds: zigged when they were supposed to zag
U.S. bonds have been in a bull market for about 20 years now. Over that time yields have fallen from well over 8% to less than 2%. So not surprisingly, at the beginning of 2014 all 74 economists surveyed by Bloomberg forecast the market would finally reverse and the U.S. 10 year bond yield would go up. Steer clear was the unanimous recommendation, with all 13 of the top U.S. investment banks and fund managers surveyed by BlackRock recommending an underweight position in global fixed interest at the beginning of 2014.
Yield on 10 Year U.S. Treasuries
Source: IRESS
In the end the 10 year U.S. Treasury yield fell from 3.01% to 2.17% (see the chart above), in other words you’d have made good money. In fact, yields on long-dated and highly rated sovereign paper all over the world went down as investors opted for security and continued to see no signs at all of inflation. According to Barclays, Eurozone bonds of more than 20 years went up by 34% and U.S. and British bonds of more than 25 years rose 27%. Here in Australia UBS forecast the 10 year bond yield would finish at 4.5%, whereas it actually finished at 2.73%. Ouch.
By the way, the consensus forecast for the U.S. 10 year yield at the end of 2015 by the 74 economists surveyed by Bloomberg this year: an increase to 3.01%. For what it’s worth.
2014 returns from selected bond indices (in local currency)
Source: Barclays, Bloomberg
Equities: dispersion you could drive a truck through
While the strategists were advising us to avoid bonds, they were urging us to pile on in to equities, which had enjoyed strong returns the year before. 9 out of 13 U.S. banks and fund managers were especially keen on European equities, since they’d lagged the rest of the world, and the same number were negative on Emerging Markets, where single digit PE’s were not hard to find. The chart below shows how that turned out (though note returns are ranked in U.S.$).
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G20 2014 Stock Market Performance (USD Benchmarked)
Source: Scutt Partners
Five of the six positive markets last year were emerging markets and everything else was down. Mind you, some of that has to do with a surging U.S.$. Here’s a similar message in a different chart which compares the Australian, U.S., U.K., Japanese, Indian, Indonesian and Chinese stock markets.
Source: IRESS
What is noticeable, apart from the strong performance from a few of the emerging markets, is the divergence. More than 50% difference between the best and worst of this small sample.
In terms of expert forecasts the average U.S. strategist underestimated the S&P500 by just over 5% and here in Australia UBS was about 5% too high. Ordinarily you wouldn’t single out an individual but there is one Australian stock picker who comes across as particularly confident. If you’d bought his top three picks for 2014 you’d have lost almost 25% of your money. Ouch.
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2014 returns from selected equities markets (local currency, before dividends)
Source: IRESS, Bloomberg
Commodities: the most un-talked about bear market
There’s no doubt the commodities markets take the prize for excitement in 2014, led, of course, by oil, which fell like a rock (see the chart below): halving from its July peak to close the year at $53.27.
Oil prices fell like a rock…
Source: IRESS
But it was a similar story for other commodities last year and the even more astonishing thing is just how far a lot of commodities prices have fallen from their recent peaks, which were mostly in 2011 at the height of the post-GFC Chinese economic stimulation program. Iron ore fell almost 50% in 2014 to close at $68.00/t, but that’s after it peaked at $187/t in February 2011! Copper dropped 16.8% over 2014 but again is down 62% from its peak.
In fact, the IMF Commodity Price Index, which is comprised of a bunch of different commodities, confirms that commodities have been in the most un-talked about nasty bear market for a few years now, falling more than 29% over the year and down 38% from its peak in April 2011.
IMF Commodity Price Index
Source: IMF, Index Mundi
There is no shortage of theories as to why commodities prices have been whacked around like they have over the past few years, some of which probably have a ring of truth:
- Chinese growth coming off its peak. After the GFC the Chinese government unleashed an enormous economic stimulus program, centred around fixed asset investment, in order to stave off unemployment and avoid civil unrest. That program peaked around 2011 along with the growth in commodities demand, so as always happens a slowdown in the rate of demand growth is enough to take the heat out of a market.
As for the past 12 months, whilst the rate of Chinese economic growth has slowed, it’s still about 7% p.a. off an already enormous base, so iron ore demand was actually up 14% last year and copper by 6%. So it seems unlikely to have caused the recent aggressive sell offs.
- The big guys flooding the market to squeeze the little guys out of business, a la Rio Tinto in iron ore and Saudi Arabia in oil. Whilst slightly conspiratorial, it’s entirely possible. In any event, the higher prices of a few years ago induced a lot of extra supply onto markets and some of that supply is profitable only at much higher prices. Expect a rationalisation of supply, it’s how markets work.
- The effect of commodities-based investment funds and ETF’s dumping holdings onto the market as investors sell out. Again, entirely possible.
Something that echoes though, we cannot find any strategists or analysts who forecast either the overall commodities bust or the recent oil price collapse.
2014 returns from selected commodities and falls from peak prices
Source: IRESS, IMF
Currencies: “it’s our dollar but it’s your problem”
It’s a cliché that movements in the Australian dollar can normally be explained in terms of changes in the U.S. dollar. That was certainly the case in 2014 when the U.S.$ began to strengthen again. We’d like to think that our dollar was trading at $1.10 back in 2011 because of the high calibre of our economy, but it was actually more to do with the U.S. economy coming out of the worst financial crisis in 80 years.
Now the A$ is trading at around 80c largely because the U.S. economy has recovered. Lo and behold the U.S.$ is now trading higher against pretty much every other currency. This is illustrated by the chart below of the trade weighted value of the U.S.$, which is calculated against a basket of other currencies with which the U.S. trades and which rose last year by more than 9%:
Trade Weighted U.S. Dollar Index
Source: U.S. Federal Reserve .
Changes in relative currency strengths over 2014
Source: IRESS
As we’ve written before, it is next to impossible to consistently and accurately forecast short-term market movements. Anything can happen, and when unforeseeable events intrude, unexpected things can happen. The best way to benefit from strong markets and protect yourself against weak markets is to remain diversified and take a long-term view.
Hopefully we’ll all have a great 2015.
