Compass - Barclays and Investment Management COMPASS February 2014 1 Contents Don’t just do something, stand there 2 Macro update: growing pains 3

Wealth and Investment Management

February 2014

Don’t just do something, stand there

Macro update: growing pains

EM currencies: The hangover drags on

As goes January…?

These investment truths we hold to be self-evident

Compass


COMPASS February 2014 1

Contents

Don’t just do something, stand there 2

Macro update: growing pains 3

The story so far ................................................................................................................ 3

Investment conclusions .................................................................................................. 6

Barclays’ key macroeconomic projections ................................................................... 7

TAA: cash (still) burning a hole in our pocket… 8

EM currencies: The hangover drags on 9

January EM FX sell-off different to the one in summer 2013 ................................... 9

Valuation adjustment may not be over yet .............................................................. 10

Higher rates and carry are not a panacea ................................................................. 10

2014 will be a tough year for EM currencies again... .............................................. 11

... yet, things may not be as bad as many think ....................................................... 12

As goes January…? 13

These investment truths we hold to be self-evident 16

A Credo for the individual investor ............................................................................. 16

Interest rates, bond yields, and commodity and equity prices in context 18

Global Investment Strategy Team 21



Don’t just do something, stand there Dear clients and colleagues,

Investment returns for moderate risk portfolios in 2013 were very healthy, if somewhat lopsided: developed stocks made the biggest contribution by far. In 2014 we think returns may be less vigorous, but more balanced. We advise staying invested.

In 2014, we see the global economy gathering a little momentum, and growing in a more synchronised fashion; and we think that investments which benefit from growth, as opposed to safe haven assets, should continue to account for the lion’s share of balanced, moderate-risk portfolios. We doubt however that the gap between the performance of developed stocks and other asset classes will be as wide this year as last.

Indeed, as we enter the year our Tactical Allocation Committee is tactically overweight cash in anticipation of an overdue setback for stocks, which may be unfolding as we write. But our view at Barclays Wealth and Investment Management, informed as ever by the work of our Investment Banking colleagues, is that such a reversal is likely to be relatively modest and short-lived, and we need to guard against trying to play it too cutely. The robust gains in 2013 do not in themselves herald a bad 2014.

Corporate profitability is likely to stay healthy, and valuations look reasonable (if no longer cheap). Meanwhile, most bonds still look expensive, even though yields are higher than last year and inflation may stay lower for a little longer. We also think it is probably too soon to turn tactically more positive on the emerging world. We are most wary of emerging bonds and currencies: stocks look better value, but even there we think it may be premature to turn tactically positive, even after their further slide in the New Year.

Of course, the euro crisis still smoulders; US (and UK?) political dysfunctionality will not disappear with the deficit(s); geopolitical danger is very much in evidence, not just in the Middle East but also in the South China Sea. But the most visible risk from our viewpoint is that investors are still placing too much faith in central banks, and too little in the underlying growth potential of the big economies: monetary normalisation could yet proceed a little more briskly than expected. That might not change our investment destination, but it could make the journey a little bumpier. And a world in which stock valuations are fuller, and liquidity injections are beginning to fade, is one in which returns are likely to be more muted than in 2013 – even as the economic backdrop improves.

Nonetheless, we think our clients will continue to enjoy better risk-adjusted returns from investing in those balanced portfolios than from sitting on the sidelines. And whatever the outcome, we think investors may find the investment credo outlined below by Greg Davies, our head of behavioural finance, a refreshing antidote to New Year exhortations to action. To paraphrase his advice: once invested, don’t just do something, stand there.

We also offer a sceptical look – with the January blues in mind – at seasonal investment maxims; and we take a closer look at those emerging market currencies. As ever, we hope this Compass assists with your financial navigation.

Kevin Gardiner, Chief Investment Officer, Europe

Kevin Gardiner

+44 (0)203 555 8412

[email protected]

mailto:[email protected]�



Macro update: growing pains The biggest economies have gathered some momentum, even as

inflation is surprising to the downside and central banks assure us they won’t be raising rates soon. This investment outlook isn’t quite the fairy story it seems – investors in emerging markets are sceptical, and we address their concerns here and in a separate essay below – but we still expect a reasonably happy ending in risk-adjusted terms…

The story so far This has been one of the more lacklustre economic recoveries (Figure 1), and was expected to be so. But to have focused on that, and to have held back accordingly from investing in risk assets from 2009, would have caused you to miss one of the most profitable US stock market rallies on record (Figure 2), underpinned by the biggest-ever rebound in corporate earnings.

The latter at least should not have come as a surprise. The biggest-ever fall in US corporate profits that preceded it was driven largely by financial asset write downs, and these were always going to slow, stop and (partially) reverse. As the US housing market has stabilized and recovered, they have duly done so.

So where next? The economic recovery is showing signs of gathering momentum and broadening out. As developed economies warm up, however, stock market returns are likely to cool – though they still look to us to offer the most attractive risk-adjusted returns in multi-asset portfolios on a medium-term view.

A warmer developed world economy is visible in forward-looking business surveys, even in the euro area. The long-established and widely influential German Ifo survey recently registered a reading of 110.6, its highest since July 2011 and well above an 23 year average of 101.2; the euro area composite PMI, a younger data series, is at its highest level since May 2011, and firmly above its 8-year average. GDP growth in the bloc is now

Kevin Gardiner

+44 (0)203 555 8412

[email protected]

Figure 1: US recoveries compared – real GDP Figure 2: US recoveries compared: stocks vs bonds

Source: Datastream, Barclays Source: Datastream, Barclays

Economies have been lacklustre in this upswing – but US stocks have sparkled

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estimated at an annualized 0.5% in the second half of 2013 - hardly a boom, but an improvement on the recessionary conditions of late 2012 and early 2013. It seems likely to accelerate modestly in 2014 (Figure 7).

In the US and UK, annualized GDP growth in the second half of 2013 now looks to have been running at around 3.7% and 3.0% respectively (a much stronger outturn than economists thought likely even as it was happening). These growth rates are unlikely to be sustained in 2014, as they were each flattered by some one-off events (most visibly in the US, a big stock-build in Q3; in the UK, a remarkable surge in retail spending in December). But at roughly 3% in each case we expect growth in 2014 to be stronger than that achieved in 2012 and 2013 as a whole. Encouragingly, in both countries unemployment is falling briskly – and faster than both the Federal Reserve and the Bank of England seem to have expected.

The improvement in economic momentum in the developed world has some solid foundations, overlooked perhaps by pundits who’ve become too attached to the rhetoric of the “Great Deleveraging” – a rhetoric that always looked overblown. Fiscal drag is set to fade as austerity programmes (and US spending sequestration) become less intense; cashflow, profitability, new technologies and old plant are making the case for boosted corporate spending on fixed investment; and, in the background, ongoing productivity gains have been steadily lifting potential output all along (as they usually do). In the euro periphery, measured cost competitiveness has improved markedly (Figure 3), alongside slow but distinct progress on labour and product market reforms, suggesting a degree of structural adjustment missed by much media commentary.

There are few signs of this more solid growth yet leading to higher inflation: immediate risks seem tilted more towards further disinflation. In the euro area, core inflation of 0.8% in January is close to December’s record low of just 0.7%, and while unemployment has stopped rising the labour market has yet to tighten appreciably. In the US and UK, where unemployment has been falling briskly, wage and price inflation nonetheless remains subdued. In the UK, CPI inflation in December 2013 actually dipped to the Bank of England’s target of 2% for the first time since November 2009.

Japan is an exception: Abenomics’ monetary arrow has pushed inflation up (largely by weakening the yen) to the (locally) dizzy heights of 1.6%. But the jury is still firmly out on whether the Bank of Japan’s cyclical objective of 2% will be hit, let alone whether the third arrow of structural supply-side reform will be loosed and hit the target.

Figure 3: Competitiveness: peripheral gains

Figure 4: US, eurozone, UK & Japan CPI inflation

Source: Datastream, Oxford Economics, Barclays Source: Datastream, Barclays

Economic momentum is not yet having a visible effect on inflation

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This benign inflation outlook is keeping the big central banks dovish. The “forward guidance” from both the Fed and the Bank of England is being amended to reassure investors that short-term interest rates will be permitted to stay low for many months yet. Most notably, in the UK, the central bank’s threshold level of unemployment looks likely to be breached more than two years ahead of schedule, but the Governor continues to stress the MPC’s reluctance to allow rates to rise. We think the ECB is poised to actually trim interest rates further – taking the deposit facility’s nominal rate formally into negative territory, something we’ve long thought feasible if not desirable. We also think the bank of Japan will announce further quantitative easing in the summer to nudge the CPI closer to that cyclical objective.

As an investor, what is there not to like in this outlook? Growth will be boosting corporate profits, while central banks remain reasonably generous (remember, the Fed’s “tapering” of its quantitative easing is a reduction in the pace at which it injects liquidity: it is not yet talking about mopping it up). If we didn’t know better, we’d be talking about a Goldilocks scenario.

In practice, however, as we’ve often noted in these pages, central banks are not always the driver of the big moves in interest rates. They are neither prescient nor omnipotent: economies might surprise them, and they may not be able to retain control of more than a small portion of the yield curve. We can’t quite bring ourselves to believe that there will be no growing pains in this cycle, and the most obvious source of them would be a faster than expected pace of monetary normalization.

The point is not lost on emerging market (EM) investors. EM currencies, bonds and stocks continue to underperform developed markets, driven partly by continuing outflows as institutional investors reallocate portfolios to benefit from the eventual rebound in developed-world interest rates (and the higher bond yields already on offer).

We note below that poor EM returns have also been driven by a number of local disappointments, including: large current account deficits, slowing growth and inflationary hangovers, and political unrest and policy uncertainty. Some EM policymakers’ responses to further pressure on their currencies in the New Year have not been helpful. Meanwhile, the calendar – and cycle – is also reminding many investors of the period of emerging underperformance sparked by the monetary normalization and Tequila crisis of 1994, which eventually segued into the Asian crisis and lasted for

Growth with low interest rates – what’s not to like?

Figure 5: Emerging vs. Developed Markets – relative price

Figure 6: Relative PE ratios

Source: FactSet, Barclays Source: FactSet, Barclays

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roughly 5 years (and cumulative stock underperformance in common currency of roughly 75%). Currently, EM stocks have underperformed for 3 years, and by a cumulative 54%, since their October 2010 relative peak. They look inexpensive, but could remain so for a while.

As yet, the poor sentiment and outflows that have are dogging emerging markets are associated with economic performance that is not actually that bad: most developed economies still envy the growth rates of Asia in particular, and the EM bloc overall seems, like the developed bloc, if anything poised to grow a little more quickly than in 2013. But the growing pains are there, and amplified by the developed world’s cyclical upswing.

Investment conclusions The long-overdue setback for developed stocks may be upon us as of late January, but as we write the retracement has been modest: the MSCI developed world index in dollars is down some 3.3% from the post-crisis high reached on January 22nd, and the direction-setting S&P500 index of US stocks is down by just 3.0% from a new all-time high reached on January 15th.

Our Tactical Allocation Committee cut its position in developed stocks to neutral in mid-November in expectation of some such setback. We retain a positive strategic view of the asset class: this is still the stock-friendly phase of the business cycle, and while stocks are no longer cheap they are still reasonably valued. We see the MSCI developed world index and the S&P500 as trading on plausible forward PE ratios of 14.9 and 15.6 respectively, for example. These are above 10-year rolling averages, but not worryingly so, and they are below the levels that might be consistent with prospective levels of profitability and the cost of capital.

Talk of an equity “bubble” seems to us misplaced. Profits can of course fall suddenly if an unexpected recession looms, but the business surveys are showing few signs of that (as noted), and the social media companies whose valuations have troubled some pundits are simply not big enough to significantly affect wider market valuations (in marked contrast to the telecoms, media and technology craziness of 2000, for example). We have noted here how more esoteric valuation metrics such as long-term cyclically-adjusted PE ratios (CAPEs) and Tobin’s Q, which suggest that stocks are more expensive, are flawed in measurement and, in the case of Q, design. Most of their statistical “explanatory” power comes from their stock price numerators, not their fancy denominators – a point that seems to have been lost on their advocates, who see their co-movement as an almost mystical indication of accuracy.

At some stage, then, our TAC may turn more tactically positive on developed stocks again (Continental Europe and the US remain our recommended overweights, and the UK and developed Asia ex-Japan are our underweights, though we expect each stock market to outperform its local bond market). The Committee seems more likely to continue to drag its heels over a similar move on EM stocks, despite their lower valuations, for reasons touched on above. As noted in our December/January Compass, we do however prefer EM stocks to EM bonds and currencies.

Developed bond markets are rallying as stock markets fall. A setback in stocks can itself be positive for bonds, inasmuch as it reflects a fading in risk appetite, and as noted above the near-term inflation news is good. However, we remain reluctant to chase higher bond prices, and stay tactically neutral (at a very low strategic weighting) on government bonds and underweight investment grade credit and emerging market bonds (as noted). If we are right, this is the wrong time to be turning positive on fixed income – which didn’t look attractively priced to us even when the 10-year US Treasury

It may still be too early to turn tactically bullish on emerging markets

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yield was back up at 3%, as it was a few short weeks back. We’d continue to focus on shorter-duration, euro-oriented bonds as offering the best insulation against what we think could be a long, grinding bear market for the asset class.

Finally, we remain tactically wary of commodities. Supply has been boosted by the high prices seen in the supercycle to date and China’s buying is becoming a little more considered. Our favourite sub-sector remains energy, particularly oil, and we continue to suspect that gold’s investment attractions are more likely to wane than wax in the context of the slow but steady monetary normalization that we expect.

Barclays’ key macroeconomic projections

Figure 7: Real GDP and Consumer Prices (% y-o-y)

Real GDP Consumer prices

2013E

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2015F

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Source: Barclays Research, Global Economics Weekly, 24 January 2013 Note: Arrows appear next to numbers if current forecasts differ from previous week by 0.2pp or more. Weights used for real GDP are based on IMF PPP-based GDP (5yr centred moving averages). Weights used for consumer prices are based on IMF nominal GDP (5yr centred moving averages).

Figure 8: Central Bank Policy Rates (%)

Official rate % per annum (unless stated)

Forecasts as at end of

Current Q1 14 Q2 14 Q3 14 Q4 14

Fed funds rate 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25

ECB main refinancing rate 0.25 0.10 0.10 0.10 0.10

BoJ overnight rate 0.10 0-0.10 0-0.10 0-0.10 0-0.10

BOE bank rate 0.50 0.50 0.50 0.50 0.50

China: 1y bench. lending rate 6.00 6.00 6.00 6.00 6.00

Brazil: SELIC rate 10.50 10.75 10.75 10.75 10.75

India: Repo rate 8.00 8.00 8.00 7.75 7.50

Russia: Overnight repo rate 5.50 5.50 5.50 5.50 5.50

Source: Barclays Research, Global Economics Weekly, 24 January 2013 Note: Rates as of COB 30 January 2013.

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TAA: cash (still) burning a hole in our pocket…

The long-overdue setback in developed stocks may have started in January. As of mid-November we have been only neutral tactically, with a large overweight in cash, in anticipation of some volatility as a PE-driven market transitions to earnings-driven mode: it may not yet have run its course. We expect to turn more positive tactically at some stage, and view our cash position as an opportunistic one: stock valuations are reasonable, if no longer cheap, and profits are growing. We would not chase the rally in government bonds, but stay tactically neutral (at a low strategic weighting, reflecting our wariness of valuations there). We stay underweight commodities, investment grade credit and high yielding fixed income (specifically, emerging market bonds).

Figure 1: Tactical Asset Allocation tilts and Strategic Asset Allocation Benchmark (moderate risk profile)

Expected 5Yr

Returns SAA

Profile 3 Strong

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Overweight

Cash & Short Maturity Bonds 1.5% 7%

Extended 15th November: counterpart to reduced weighting in developed equities

Developed Government Bonds 1.4% 4%

CB buying and falling supply offset by high valuations and likely recovery in risk appetite

Investment Grade Bonds 2.3% 7%

Very expensive: little spread compression left to go for, prefer lower tier 2 banks and insurers

High Yield & Emerging Markets Bonds

5.0% 11%

Expensive, and vulnerable to reversal of inflows as slow process of monetary normalization begins

Developed Markets Equities 7.9% 38%

Cut from overweight 15th November: transition from liquidity to growth-driven market could see a setback

Emerging Markets Equities 10.6% 10%

Structurally attractive but tactically still vulnerable to tapering concerns

Commodities 4.8% 5%

Cut 11th July: monetary normalisation, more US-focused cycle & rising supply threaten gold and other metals

Real Estate 8.0% 4%

Mixed: US and Europe offer best value; investable Asian markets look expensive

Alternative Trading Strategies 3.5% 14%

Regulation, and lower leverage, leave this diversifying asset class without tactical appeal

As of July, we use qualitative descriptions of our Tactical positions relative to their Strategic benchmarks, ranging from ‘strongly underweight’ to ‘strongly overweight’. This is a shift away from the percentage-based reporting method we used in the past. Our Strategic Asset Allocation (SAA) models offer a mix of assets that over a five-year period will in our view provide the most desirable mix of return and risk at a given level of Risk Tolerance. They are updated annually to reflect new information and our evolving outlook. Our Tactical Asset Allocation (TAA) tilts these five-year SAA views to reflect our shorter-term cyclical views. For more detail, please see our Asset Allocation at Barclays white paper and the February 2013 edition of Compass. Source: Barclays

Figure 2: Total returns across key global asset classes

Note: Past performance is not an indication of future performance. Index Total Returns are represented by the following: Cash and Short-maturity Bonds by Barclays US Treasury Bills; Developed Government Bonds by Barclays Global Treasury; Investment Grade Bonds by Barclays Global Aggregate – Corporates; High-Yield and Emerging Markets Bonds by Barclays Global High Yield, Barclays EM Hard Currency Aggregate & Barclays EM Local Currency Government; Developed Markets Equities by MSCI World Index; Emerging Markets Equities by MSCI EM; Commodities by DJ UBS Commodity TR Index; Real Estate by FTSE EPRA/NAREIT Developed; Alternative Trading Strategies by HFRX Global Hedge Fund. The benchmark indices are used for comparison purposes only and this comparison should not be understood to mean that there will necessarily be a correlation between actual returns and these benchmarks. It is not possible to invest in these indices and the indices are not subject to any fees or expenses. It should not be assumed that investment will be made in any specific securities that comprise the indices. The volatility of the indices may be materially different than that of the hypothetical portfolio.

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Developed Markets Equities

High Yield and Emerging Markets Bonds

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Developed Government Bonds

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2013 2014 (through 28 January 2014)

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EM currencies: The hangover drags on EM currencies are being hit hard again. 2014 is likely to be another

tough year for EM FX: structural problems remain and valuations are still not appealing. But investors may start to differentiate, leading some EM currencies to recover. We avoid ZAR and TRY as their fundamentals remain challenging.

January EM FX sell-off different to the one in summer 2013 EM currencies came under broad-based pressure in the second half of January, prompting many to compare the recent sell-off to events of the last summer, when they also weakened across the board. However, there are key differences between the situation now and then, in our view.

Last year’s sell off in EM assets was largely caused by the market suddenly repricing the outlook for US monetary policy normalisation and the consequent sharp rise in US longer-term yields (for example, the 10-year US treasury yield rose by 100bps within two months). In contrast, the EM jitters this time around appear to have a bigger “local” component, ranging from concerns about the EM growth outlook (exacerbated by the below-consensus Chinese PMI reading on 23rd January) to more idiosyncratic factors (for example the 12%-13% depreciation of the Argentina peso). The negative sentiment unsurprisingly punished the currencies of the most vulnerable economies: Turkey and South Africa, with their currencies down by 6% and 7% respectively so far this year.

Are EM currencies out of the woods yet? Not necessarily. Market sentiment remains particularly downbeat and despite material adjustments in EM currencies across the board (the equally weighted index of EM currencies is down by 2.4% against USD so far this year and by 6.6% since May 2013 – Figure 1), structural problems remain and valuations are still not necessarily attractive in general.

Petr Krpata, CFA

+44 (0)20 3555 8398

[email protected]

The recent sell-off was caused by EM specific factors

Figure 1: EM currencies continue falling

Figure 2: EM FX is still not generally cheap

Source: Barclays, Bloomberg Source: Barclays, EcoWin, BIS.

*BIS data only available until end-2013, Jan 2014 extrapolated by Barclays

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Figure 3: ZAR valuation adjusted, but not fundamentals Figure 4: While TRY’s carry adjusted after its collapse, ZAR’s remains the same

Source: Barclays, EcoWin, BIS Source: Barclays, Bloomberg

Valuation adjustment may not be over yet Figure 2 shows that despite their pronounced fall since May last year, EM currencies as a whole did not cheapen enough to make them a clear buy. Of course, there are differences among them. As Figure 3 depicts, the rand (ZAR) has seen a substantial fall, and does now look inexpensive (the currency has fallen by 25% against USD since 2013). But even here, as always, valuation alone does not make a convincing investment case.

Not only has ZAR been punished for its reliance on external funding in 2013 (along with other current account deficit countries such as Turkey (TRY), Brazil (BRL), India (INR) and Indonesia (IDR)), but a lack of structural reforms, a reluctance to hike rates (until this week) and ongoing political risk (due to labour disputes) has caused it to decouple (along with TRY) from the other deficit currencies which have made some progress. India for example has materially improved its current account deficit and its new Central Bank governor has restored the Bank’s credibility, whilst Brazil has embarked on a rapid tightening cycle to tame inflationary pressures and has rolled out a programme to intervene against excessive BRL weakness.

The lack of tangible measures, without the backing of attractive interest rates or carry (even after the latest 50bps rate hike), still makes ZAR vulnerable going forward. As Figure 4 shows, ZAR’s implied carry is not high enough relative to its fragile peers, and does not provide sufficient prospective returns to offset the potential risk.

Higher rates and carry are not a panacea Of course, higher interest rates are not a complete remedy. While higher rates make long positions in the currency in question more attractive (as one benefits from the tailwind of high rates) and shorting the currency more expensive (as one needs the currency to depreciate by an amount equal to the interest rate differential in order to at least break even), they do not deal with root cause of the problem (structural vulnerabilities). Indeed, they merely buy time for reforms to be implemented. They also do not come for “free”. The obvious side effect is a further slowdown in growth, which is of course not desirable in an environment already characterised by market worries about a slowdown in EM growth. But a hangover comes after the party ends, and there are no easy fixes.

Moreover, the effect of rate hikes may be muted when they are coupled with mixed messaging from the central bank. Turkey is a case in point: although it materially hiked interest rates in January (425-550bps across its main policy rates), the bank changed its

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Although ZAR weakened materially, this does not justify a more upbeat outlook

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While higher interest rates may ease selling pressure on currencies, it is not a long term solution



policy framework once again, raising eyebrows among market participants. Under these circumstances, such hikes look like a hasty response to market tremors, rather than a careful and considered policy decision.

Turkey’s travails provide a good reminder that nothing should be taken for granted. Not so long ago (in late 2012 to early 2013), the Central Bank of Turkey (CBT) was acting to prevent excessive appreciation of the trade-weighted TRY (indeed, TRY was in fact the currency with the lowest volatility in the CEEMEA region – Figure 5). A few short years back the Brazilian real also was facing pronounced upward pressure. This merely underscores that the party cannot last forever, and that the end often comes from out of the blue.

Figure 5: TRY implied volatility increased materially

Source: Barclays, Bloomberg

2014 will be a tough year for EM currencies again... Looking ahead, we retain our view that 2014 is likely to be a challenging year for EM currencies (as argued in December/January Compass). As we have seen in recent weeks, structural issues remain among some EM economies (and are becoming more prominent after the taper-related indiscriminate sell-off in EM assets last year) while the positive effects of reforms, if implemented, will take time to materialize.

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Not so long ago, Turkey’s central bank was acting to prevent excessive TRY appreciation, but now…

Figure 6: Clear divergence between G10 and EM currencies

Source: Barclays, Bloomberg

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G10 and EM currencies' risk sensitivity

decoupled




Our expectations of a stronger USD and rising core G10 yields do not bode well for EM FX either. Higher USD funding costs will be particularly problematic for countries that benefited from a credit-fuelled boost in consumption over past years, accumulating foreign liabilities as a result.

Moreover, and unlike their G10 FX peers, the EM FX segment remains highly correlated with risk, making it vulnerable in times of stress (as Figure 6 shows, the drop in EM FX correlation with risk has lagged G10 FX).

... yet, things may not be as bad as many think Is another crisis like the one that hit Asia in 1997 looming? Perhaps not. We think that the EM bloc as a whole is in a qualitatively better position than it was then. Among other things, EM countries have lower external deficits and the overall EM current account balance is in better shape (Figure 7). Balance sheets generally are in better shape now. Moreover, we do not see the worries that triggered the latest EM sell-off as revealing anything new: the structural slowdown of the Chinese economy is not new news, while Argentina is a frontier market whose woes are well-known. Moreover, although EM currencies look expensive on the whole, some regions are more attractive than others. As Figure 8 shows, Asian emerging currencies are now close to their fair value, as opposed to those in EMEA, which look dear.

The outlook for structurally weak economies and their currencies is not favourable, particularly if drivers change away from the DM-induced “one size fits all” sell-off (as QE tapering is now partly priced in) to differentiation between individual EM economies by investors. However, the prospect for differentiation provides scope to identify the potential winners and losers among EM countries. Looking at fundamentals, ZAR and TRY still look vulnerable (despite recent moves by their central banks), whilst the outlook for INR has materially improved (having markedly decoupled from the poor performance of the first two currencies). On the other hand, MXN should eventually benefit from its economic reform programme (structural reform being something which many EM countries have yet to engage with). Yet the overall shift is clear: EM currencies are no longer a one way bet, and DM currencies are regaining ground, USD and GBP in particular. While we can’t pretend to have foreseen the suddenness of the New Year EM sell-off, we have been positioned for DM FX outperformance – as we noted in the December/January Compass.

Figure 7: EM in better shape than in 1997 Figure 8: EM Asia looks most attractive within EM FX

Source: Barclays, EcoWin, OECD Source: Barclays, EcoWin, BIS

*BIS data only available until end-2013, Jan 2014 extrapolated by Barclays

We think that EM economies are in better shape than in 1997

The outlook for some EM currencies is qualitatively better than for others

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As goes January…? Equity markets have started the new year on a weak footing, and

“as goes January, so goes the year” – so they say. But like “sell in May and go away”, this seasonal motto is not always useful.

Developed stocks have fallen in January (by around 3% in dollars). The stock market saying suggests January’s move is a good predictor of the market’s direction for the year as a whole. Should we worry? Tactically no, since we’re no more than neutral on developed stocks, and are waiting for a setback to add to positions, as noted above. But strategically, maybe: we’re expecting a positive year. How accurate is the saying?

It needs some clarification at least. Stocks rise in most months (because profits grow in most months) and so a positive January wouldn’t tell you anything special. For the MSCI World index since 1970, there have only been 11 negative years (1 in 4); for the S&P500 since 1964 there have been 13 (roughly the same proportion).

Christian Theis, CFA

+44 (0)203 555 8409

[email protected]

There is some evidence of seasonality in stock market returns – but it has varied over time

Figure 1: Monthly moves in developed stock markets

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Source: Datastream, Barclays

Figure 2: Monthly moves in the S&P 500 index (US stocks)

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Of the 15 instances of a negative January for the MSCI World index, 7 turned into a negative year (so the retrospective odds of a full year decline rise to around 1 in 2, and almost 2 in 3 negative years had a negative January in them). In the 19 instances of a negative S&P January, 9 turned into a negative year (again, almost I in 2, and 2 in 3, respectively). So if history is a guide (and as we are bound to point out, it isn’t always), the odds of a full year decline after a negative January are broadly even – a coin flip. The odds rise further if we look for negative Januarys being followed by below average years – but since the averages are double digit gains, this is not too troubling.

The most familiar seasonal investing advice is ‘Sell in May and go away’. It originated in the City of London: the full saying is “Sell in May and go away; come back on St. Leger’s Day”. The St. Leger Stakes is the oldest of England’s five horseracing classics and the last to be run, around mid-September. The advice is closely related to the academically-researched Halloween effect, which suggests buying in October.

Clearly, selling in May didn’t work last year: the MSCI World index rose 10% during May to October. In fact, the advice hasn’t worked more often than it has: developed, US and UK markets have usually risen in the May-October period (roughly 2 times out of 3). But as the charts suggest, on average the November to April half year has been more

Figure 3: Monthly moves in the FTSE All-Share index

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Selling in May has not been a good tactic – but November-April has been the stronger half-year

Figure 4: Monthly moves in implied US stock volatility – the “Fear index”

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positive than May-October – by roughly 7%, 6% and 11% for the MSCI World index from 1970, the S&P500 from 1964 and the FTSE All-Share from 1965 respectively.

More generally, Figures 1-3 show that there are no individual months with consistently positive or negative stock returns on average in each period shown, though December comes close (the exception there being the S&P in the 1964-9 period). There are some clear patterns in implied stock market volatility (Figure 4) – it is lowest in June, and seems to spike in September and October – but the VIX index is relatively young.

Figure 5: Monthly movements in government bond prices

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There are few investment sayings in bond markets, but some apparent seasonality nonetheless. For Treasuries, bunds and gilts since 1980, August to November are the stronger months (Figure 5). There is also some (less surprising, perhaps) seasonality visible in commodity prices since 1951 (Figure 6). Agriculture and Energy have been weaker in September and October.

There could be good reasons for these various apparent seasonal effects – the timing of holidays, temperate weather and harvests, for example – but they are not supposed to exist in “efficient” markets. A more rigorous test of this however would require taking transactions and opportunity costs into account. For the time being, we simply note that January may not be telling us much about stocks in the rest of 2014.

Figure 6: Monthly movements in commodities (CRB spot indices)

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These investment truths we hold to be self-evident The broad remit of our unique Behavioural Finance team is to: help

investors make better financial decisions. As a result we spend a lot of our time thinking hard about what constitutes good and bad investment decision making.

In many domains it is reasonably clear what behaviour is ‘good’, for example: exercise (more), eating (less), gambling (less). In investing, by contrast, it can often appear that there is widespread disagreement on what constitutes ‘good’ behaviour. Should one invest more or less? Invest now, or wait for more certain times?

This is made worse by the fact, discussed in my essay in last month’s Compass , that over any short or medium time horizon, investing outcomes are driven substantially by chance and by events that are out of the control of the decision maker. Any single good decision can turn out badly, and bad decisions can quite accidentally turn out well. We don’t learn much from observing the outcome of individual decisions, but over time many bad decisions will add up to poor results in aggregate. Thus, making good investment decisions requires us to be following a clear and coherent set of principles that amount to a good decision making process.

To help ensure that investment decisions are tipped in favour of good decisions, which over time will maximise your chances of good outcomes, the Behavioural Finance team has gone back to fundamentals to extract what we believe are seven core truths that all investors can subscribe to as articles of faith. Of course these are broad principles, and there may be odd exceptions to the rules, but build your decision process around these, and you can be confident your investing behaviour will be better as a result. Each is followed, in bold, with the generic actions this belief implies.

A Credo for the individual investor 1. Successful investing requires a safe environment – above all it requires sufficient

financial liquidity and/or insurance to ensure the investor gets to choose when to sell (is not forced to sell) – Work out what you can afford to invest

2. Getting fully invested as early as possible, at the level of risk appropriate to your risk profile, rather than leaving available capital unutilised delivers the best financial outcomes over time – Put it to work

3. Over time diversification delivers the best returns to all investors for the amount of risk taken regardless of investment amount – Diversify to reduce unnecessary risk

4. The most certain drag on investment performance are costs, fees and taxes. Make sure you know what you’re paying for and why – Reduce costs wherever possible

5. Inaction delivers better financial outcomes than frequent buying/selling – investment returns are about time in the market, not timing the market. Stock picking, currency speculation and market timing are usually costly over time and best left to professionals (if at all) – Do less than you’re inclined to

Greg B Davies

+44 (0)203 555 8395

[email protected]





6. Short term investment outcomes involve considerable luck and it is almost impossible to differentiate luck from skill in the short-term1; in the long term, however, good investment process is likely to pay off – Focus on the long term

7. Long-term investment success requires being sufficiently emotionally comfortable with your portfolio through the investment journey to stick with your plans and follow a good investment process – Reduce your anxiety

Of course, you should bear in mind that, no matter what principles you follow, investment requires taking risk, and risk means investments which can fall in value (and most likely will at various points along the journey). You may get back less than you invest.

1 This is not to say that skill doesn’t exist, just that it can only be genuinely discerned over relatively long time periods.



Interest rates, bond yields, and commodity and equity prices in context* Christian Theis +44 (0)20 3555 8409 [email protected]

Figure 1: Short-term interest rates (global) Figure 2: Government bond yields (global)

Source: FactSet, Barclays Source: FactSet, Barclays

Figure 3: Inflation-linked real bond yields (global) Figure 4: Inflation-adjusted spot commodity prices

Source: Bank of America Merrill Lynch, Datastream, FactSet, Barclays Source: Datastream, Barclays

Figure 5: Government bond yields: selected markets Figure 6: Global credit and emerging market yields

Source: FactSet, Barclays *Monthly data with final data point as of COB 28 January 2014.

Source: FactSet, Barclays

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Figure 7: Developed stock market, forward PE ratio Figure 8: Emerging stock market, forward PE ratio

Figure 9: Developed world dividend and credit yields Figure 10: Regional quoted-sector profitability

Figure 11: Global stock markets: forward PE ratios Figure 12: Global stock markets: price/book value ratios

All sources on this page: MSCI, IBES, FactSet, Datastream, Barclays

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Global Investment Strategy Team

EUROPE

Kevin Gardiner Chief Investment Officer, Europe [email protected] +44 (0)20 3555 8412

Peter Brooks, PhD Behavioural Finance specialist [email protected] +44 (0)20 3555 1261

Greg B Davies, PhD Head of Behavioural and Quantitative Finance [email protected] +44 (0)20 3555 8395

Emily Haisley, PhD Behavioural Finance [email protected] +44 (0)20 3555 8057

Petr Krpata, CFA FX Strategy [email protected] +44 (0)20 3555 8398

Antonia Lim Global Head of Quantitative Research [email protected] +44 (0)20 3555 3296

Christian Theis, CFA Macro [email protected] +44 (0)20 3555 8409

AMERICAS

Hans Olsen, CFA Chief Investment Officer, Americas [email protected] +1 212 526 4695

Laura Kane, CFA Investment Strategy [email protected] +1 212 526 2589

David Motsonelidze Investment Strategy [email protected] +1 212 412 3805

Kristen Scarpa Investment Strategy [email protected] +1 212 526 4317

ASIA

Benjamin Yeo, CFA Chief Investment Officer, Asia and Middle East [email protected] +65 6308 3599

Eddy Loh, CFA Equity Strategy [email protected] +65 6308 3178

www.barclays.com/wealth

February 2014UK0045

www.Barclays.com/wealth

Documents

Compass - Barclays and Investment Management COMPASS February 2014 1 Contents Don’t just do something, stand there 2 Macro update: growing pains 3