• Tensions between France and Germany will produce the next Eurozone 'wobble' as the results of the ECB stress tests will expose altruistic weaknesses.
• UK interest rates will not rise in 2014 despite an improving employment outlook.
• M&A will continue to pick up as CEOs see the era of 'ultra-cheap money' coming to an end.
• Corporate earnings will pick up along with the economic outlook to drive up equity prices in conjunction with the expansion of valuation multiples.
With the start of the new year, Frank Investments outlines its view of what the British public can expect to see across the UK and global economy in 2014.
As well as considering the outlook for the domestic economy, the Eurozone and foreign markets, Paul Sedgwick, Head of Investment at Frank Investments, outlines his 2014 predictions and the potential impact on capital markets.
The UK & the Eurozone:
Paul Sedgwick, Head of Investment at Frank Investments, said: "On the surface, everything in the garden appears rosy as we enter 2014, although the underlying risks should not be ignored.
"We are in a five year secular bull-market in equities. However, despite the improving economic outlook and the falling unemployment levels, interest rates are not likely to rise this year in either the UK or the US as, barring any shocks from an oil price spike, inflation will remain subdued.
"The next Eurozone 'wobble' is likely to come from France as continued tensions between the weak French economy and the booming German economy will once again place the European Central Bank (ECB) in a difficult position.
"On the one hand, the ECB will need to prevent deflation taking hold within the Eurozone economy – with the consequence of increasing the value of debt – whilst on the other hand, it will need to pay attention to the wishes of the Germans, who would be happy with a modest rise in rates.
"Germany, despite its history and public stance on inflation, will be as aware as anyone of the perils of deflation in the Eurozone economy and its potential impact on peripheral economies. The catalyst for the ECB to move interest rates could be the results of the bank's stress tests, which is likely to expose the weakness of the French banking sector as the country continues to struggle.
"Deflation will remain a threat in the Eurozone and, combined with the weakness of the French economy, this will force Mario Draghi to try and persuade Germany to authorise the use of some of the tools at his disposal to further stimulate the Eurozone economy.
"Despite fundamentals suggesting a higher exchange rate, the euro will eventually fall back to around 1.3 euros to the dollar, as this is the optimum level for both the US and Eurozone economies."
Bonds vs. Equities:
Paul Sedgwick, continued: "2014 will see the continuation of rotation from bonds into equities as investors begin to lose the fear of equities that started post 2008.
"At this moment in time, greed appears to be in equities and fear in bonds, both driven by the improving economic outlook and the central bank's pursuit of accommodative monetary policies. We are probably half way through a five-year secular bull-market and equities feel a little over-loved at present. Therefore, in the short-term equities are not well prepared for any shocks.
"Equity valuations remain attractive despite the recent rises, particularly when compared to credit. The bond market is the key as rates need to normalise, but this has to be done in a measured way. Any sharp fall in bond prices will quickly unnerve equity investors.
"M&A will continue to pick up as CEOs see the era of 'ultra-cheap money' coming to an end. Despite the recent rise in returns to shareholders, they remain below the levels of 2008. Therefore, the focus of corporates will also remain on returning cash to shareholders through increased dividends and share buy-backs. In addition, corporate earnings will pick up along with the economic outlook to drive up equity prices in conjunction with the expansion of valuation multiples."