2013 – A reminder of the benefits of diversification

Key Themes in 2013

  • Strong gains in developed markets
  • Gold & base metals weakness in $A retreats
  • Fixed interest returns below long term averages
  • In Australia, rising bank stocks offset falling resource stocks
  • 2013 reminded us about the benefits of discipline and of seeing past the daily headlines to the long-term opportunities for building wealth

The benefits of global diversification were never more evident than in 2013. The major developed world markets, which had been near the centre of investor concerns in recent years, led the world with historically strong gains.

Economic recovery hopes helped make the US, Japan and Europe the year’s star share markets.

The US S&P-500 had its best year since 1997, reaching record highs and delivering a total return for the year of 32.4% in US dollar terms. It was the fifth consecutive year of gains in the US, while daily volatility fell to a seven-year low. The periodic US government debt ceiling showdowns amid brinkmanship in Washington had little lasting impact.

In Japan, the Nikkei stock average rose 57% in local currency terms to post its strongest performance since 1972. Helping to drive returns there was intense stimulus by Japanese policymakers to curb 15 years of deflation and weaken the yen.

In Europe, the centre of concerns in recent years over debt and the single currency, strong gains were made across the board, led by Germany and France. Even Greece, the poster child for the euro crisis, posted gains of around 28% in local currency terms.

China grew at its slowest pace in 20 years as policymakers sought to rebalance growth away from exports to domestic drivers. India, too, was hit by decelerating growth, alongside rising prices.

This contrast between the developed and emerging markets explained some of the relative underperformance of the Australian market, where signs of a slowdown in the mining boom savaged resource stocks, particularly at the small end of the market.  This also contributed to a 14% fall in the Australian dollar relative to the US dollar.

Alongside the commodity retreat, the $A was hurt by expectations of a narrowing interest rate premium. As the RBA continued to cut interest rates, the Fed began to pare its stimulus. US 10-year Treasury note yields climbed from 1.76% to 3.01%, the largest rise in four years.

Commodities[1] fell for a third consecutive year. Precious metals suffered the biggest declines, with gold dropping the most in three decades. Base metals also fell, led by nickel with a loss of 19%.

While weaker commodities hurt Australian shares, this was offset by gains in banks and consumer staples. That helped drive the S&P/ASX 300 accumulation index just under 20% higher. 

Sharemarkets2013 

Sector performance 2013  

Timeline of News Events – 2013

The below graph highlights some of the year’s major news events in context of broad Australian market performance. These headlines are not offered to explain market returns but to show that investors should view daily events from a longer-term perspective and avoid making investment decisions based upon the "popular" news.

 

United States

The US economy quickened its pace slightly in 2013, with estimated GDP growth of 2.3% for the year, up from 2.0% in the prior two years.

US corporate profits reached their highest level as a share of GDP in the post-war era, fuelled by productivity gains, falling wages and cost-cutting. Initial public offerings (IPOs) jumped 59%, the busiest year for floats since the crisis. Firms also issued $1.4 trillion in investment grade debt, surpassing the previous year’s record.

With interest rates remaining at historic lows, attention focused on hints from the US Federal Reserve about when and how fast it would taper its so-called “quantitative easing” program that it has used in recent years to anchor long-term lending rates.

After shifting signals that unsettled markets through the year, the Fed confirmed in December that it would move cautiously and gradually in unwinding the stimulus, initially cutting its monthly asset purchases by $10 billion to $75 billion.

The housing market also improved, although most of the gains in home prices and sales came earlier in the year. Rising stock prices and housing prices helped boost household net worth to a record level in Q3.

Europe

Economic conditions improved a little in the euro area, with growth returning mid-year after an 18-month recession. Germany was the best performer, aided by France and a return to growth in Italy and Spain.

Borrowing rates in the worst-hit countries declined, consumer and business sentiment improved and foreign investment recovered. However, unemployment remained historically high at around 12% for the euro zone as a whole.

Asia

Japan was a standout performer in 2013, helped by the unprecedented stimulus of Prime Minister Shinzo Abe who came to power in late 2012 on a pledge to rid the nation of the deflation that has plagued it for 15 years.

While Chinese economic growth slowed in 2013, indications were it would come in slightly above the government’s forecasts of 7.5%. This would be the weakest pace of growth in China since the 1997-98 financial crisis.

In reforms announced in November, the Chinese government is seeking to restructure the economy so that it is driven more by consumption and services than exports and investment.

Australia

Australia is looking for another growth engine to replace mining. Manufacturing has been hit by the strong local currency, as evident by General Motors’ announcement it would join Ford in closing its Australian manufacturing operations.

The Reserve Bank of Australia cut official cash rates twice in 2013 to 2.5%.

Global Market Summary for 2013

For all the uncertainties in 2013 over the future of Federal Reserve policy and the sustainability of growth in emerging economies, equity markets still delivered solid performances across the board.

Developed markets led the way, with a gain in $A terms of just over 48%, as measured by the MSCI World-ex Australia index. The 14% decline in the $A over the year added substantial value to unhedged investors. In local currency terms, the US market had its best year since 1997, while Japan notched up its best annual market performance in 41 years.

The economic recovery signs and expectations of reduced policy stimulus hurt major fixed income indexes. Longer-term bonds underperformed shorter-term, although economic recovery signs boosted credit risk appetites. The Barclays Global Aggregate index, hedged to $A, returned 2.27% for the year. This was below the return from bank bills.

Real estate securities had a relatively lacklustre year after the big gains of 2012, but the sharp fall in the $A helped unhedged investors in global REITs.

Banks were a significant contributor to market performance in Australia, providing the bulk of gains.

All developed markets tracked by MSCI had positive total returns. Top performers over the year were Ireland, Finland, Denmark and the US. At the bottom were Singapore, Australia and Canada. In the emerging markets, Greece1, Egypt and Taiwan were the top performers, while Peru, Turkey and Indonesia were the laggards.

1 On November 27, 2013, MSCI reclassified the MSCI Greece Index from Developed Markets to Emerging Markets. Consequently, Greece was not considered an emerging market for the entire 2013 calendar year.

2013 MSCI index

 Developedcountriesreturn Emergingcountries

Summary

The past year was an extremely solid one in global equity markets, with many of the factors that had worried investors in previous years becoming irrelevant.

For some investors, the strong returns of the past two years may mean 2014 provides an opportunity to reduce overall investment risk in their portfolio and thereby increase the probability that their financial and lifestyle goals will be achieved.

For other investors, the lesson from 2013 was about the virtues of broad diversification across and within countries, sectors and asset classes, and the benefits of discipline and of seeing past the daily headlines to the long-term opportunities for building wealth. 

Authors: Rick Walker & Greg Keady
 
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[1] As measured by the Dow Jones-UBS commodity index in US dollars

 Note: This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.