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How good were market strategists' 2013 calls?

Bill McQuaker examines which predictions for 2013 came true and finds many were mistaken, undone by the Fed’s intention to reduce quantitative easing.

No looking back...

It is the time of year when market strategists and commentators outline their views for the year ahead. Typically they do not dwell much on what has happened since they last put pen to paper, perhaps for fear of facing up to their errors of judgment. Anyone who has been in markets for a while knows mistakes are inevitable, as unforeseeable events collide with market sentiment to shape returns.

But just how accurate were last year's predictions? Let's go back and look at what commentators told us, and what actually happened...

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Economics

What they told us...

For the third year in a row market strategists envisaged an improvement in economic growth led by China and the US. Little was expected to happen in Europe, while the UK was thought to be in the midst of a double-dip recession. None of the commentators paid much attention to Abenomics and the Japanese economy. Few said inflation would decline.

What happened...

The growth story that unfolded in 2013 was different in almost every regard. The US and China disappointed once again, as did the entire emerging markets bloc. The UK did not double-dip, and instead enjoyed a dramatic improvement in growth, led by a stronger housing market.

Expectations for Europe were closer to the mark. Growth returned in the second half of the year, but at an anaemic rate. This modest forecasting success was cancelled out by a collective failure to foresee the major upturn in fortunes in Japan.

The other example of collective myopia was the failure to spot a surprising decline in global inflation rates. Few commentators saw it coming and, to be fair, markets appear not to care. Time will tell if that complacency is warranted.

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Politics

What they told us...

Accurately anticipating political developments makes forecasting asset prices seem like child’s play. But many market strategists and commentators looked forward to a less troubled 2013.

What happened...

They were right. There were painful moments along the way. The Cyprus default and the Syrian civil war spring immediately to mind. But for the most part, politics took a back seat this year.

That said, the importance of the political dimension continues to grow. The attempt at rejuvenating Japan is a massive political project, led by prime minister Shinzo Abe. In the UK, politicians of all shades are quick to point to market failure to justify new initiatives. And most profoundly, the world’s major central banks systematically interfere with market mechanisms when they attempt to ease monetary conditions and provoke animal spirits. Goodbye invisible hand, hello benign dictatorship?

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Investment flows

What they told us...

The majority opinion at the start of the year was that money would continue to flow into bonds, as it had done consistently since 2009. Only a few brave voices spoke of the possibility of a ‘great rotation’ away from bonds and into equities, but the consensus was that such a move was still some way off.

What happened...

Those bold commentators were right and were rewarded for their temerity. The first half of the year was characterised by flows into both bonds and equities, but since the middle of the year flows into bonds have dried up while equity portfolios have mushroomed.

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Markets

What they told us...

A year ago no-one wanted to know about European equities. US was best, emerging markets were due to catch up. A few macro-driven investors had spotted something was happening in Japan, but most could not remember the last time they gave it a thought. Bonds were as attractive as the equity market and, risk-adjusted, a better place to be invested.

What happened...

Some of the strategists were right and some were wrong. They were right about the US equity market, which for the year as a whole has outpaced most regions. They were dead wrong on Japan, which has been the standout performer of 2013. And they were awry on emerging markets.

Emerging markets have continued to underperform and, on current readings, will end the year down. On bonds, the mood has changed but no-one feels they have done too badly (yet).

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End of year report

Why did the strategists and commentators so often get it wrong? Myriad factors help to explain why things turned out differently, but the most important influence can be summed up in one word: taper.

Markets were doing a fine job of following the script until June when the US Federal Reserve broke the news it was considering scaling back its programme of quantitative easing. That caused a severe setback in bond markets, which has yet to reverse fully.

That unexpected event appears to have dented investors’ confidence in bonds and fuelled the upturn in the appetite for equities.

All in all it has been a good year for owners of capital. That said, it is curious that sentiment towards asset markets seems to have improved in the second half of the year, despite most diversified asset portfolios peaking in May. Sharp losses have been partially reversed, but most investors would have been better off cashing in at the end of May instead of running risk for the balance of the year.

The special seductive language of the equity market (all-time highs, instant profits, long-term growth) appears once again to have cast its magic spell. In a world that still faces considerable long-term challenges, we would be wise to resist getting too carried away.

Bill McQuaker is head of multi-asset at Henderson Global Investors.

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