Investing in 2014: The big questions to consider this year

LAST year turned out to be a pleasant surprise for global markets, spurring optimistic forecasts for the year ahead. But there's plenty that could still go wrong.

So what are the big questions for 2014?

Will Britain raise interest rates?

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After three years of virtual stagnation, the economy surprised almost everyone by roaring back to life in 2013 – and the recovery is expected to strengthen. An FT poll of 100 economists put average expectations of growth in 2014 at 2.4 per cent and many reckon it could go higher. Britain, notes Brian Hilliard of Societe Generale, is in a "sweet spot", as growth gathers pace and "improved confidence suffuses the whole economy".

That, however, poses a dilemma for Bank of England governor, Mark Carney. The governor assures us that he won't "pull the rug out" from the recovery by hiking rates above the current 0.5 per cent too soon. But there's widespread expectation that that the seven per cent unemployment threshold, central to his forward guidance on rates, will be achieved this year.

And a bubbling housing market (the Halifax predicts a further eight per cent rise in prices) will add to inflationary pressure for a hike. The consensus among economic forecasters is that the Bank will hold off until 2015. But a Capital Spreads survey found that almost 40 per cent of fund managers in the City think the BoE will be forced to raise rates by year-end.

Will the FTSE 100 beat its record high?

Probably. After climbing 14.4 per cent in 2013 to finish at 6,749, the index is once again within striking distance of the 6,930 high reached on the last day of 1999. Bullish sentiment suggests it will breach the 7,000 barrier this year. Analysts at Brewin Dolphin, Citigroup and Capital Economics all predict it will end 2014 at between 7,200 and 7,500 – particularly if sentiment shifts back to large cap stocks.

The running in 2013 was mainly made by small caps. Indeed, the best performing UK fund overall was River & Mercantile UK Equity Smaller Companies, which delivered returns of 51.4 per cent. Will small remain beautiful in 2014? Many think so, says The Times. Stockbroker Killik & Co reckons there's scope for "continued outperformance in the coming year", aided by the prospect of more merger activity and new rules allowing AIM shares to be held in Isas.

Will emerging markets continue to underperform?

They certainly had a disappointing year in 2013, with funds generally finishing near the bottom of performance tables. There were some exceptions. Investors brave enough to back Venezuela's tiny stock market "quintupled their money" says the Sunday Telegraph – mainly because local investors ploughed cash into shares to offset the plummeting Venezuelan Bolivar. Last year also saw giant ructions in currency markets globally, triggered by fears surrounding the impact of the US Federal Reserve's plan to "taper" its giant stimulus programme. Those concerns are likely to predominate again this year. "The biggest risk of 2014", says Albert Edwards of Societe Generale, is a "re-run of the 1997 Asian crisis as the Fed tapers".

There's particular concern about the outlook for the so-called "Fragile Five" – Indonesia, India, Brazil, South Africa and Turkey, whose large deficits make them particularly vulnerable to a sudden shock.

What can we expect from China?

Depending on your world view, says David Stevenson in the FT, China's financial system is either "teetering on the edge of a credit bubble, or more stable than we think". Many China bears remain convinced that 2014 will bring a crash given the chaotic shadow banking system, but my "oversized bet" is that Chinese markets will surprise on the upside. Analysts at Charles Stanley are also China bulls, arguing that far-reaching economic reforms outlined in the recent plenum have transformed the outlook, and that China is "preparing the ground" to lead the global economy "for decades to come".

If that's true, it's not priced into local markets which are still trading at rock bottom valuations, despite predictions that GDP is likely to come in above seven per cent again next year.

Will Japan continue to delight?

Japan's stock market has risen by nearly 60 per cent in the past year on the back of PM Shinzo Abe's economic reforms, but not everyone is convinced that "Abenomics" will provide the platform for further growth. Leading the bears is economist Anatole Kaletsky who, in a piece for Reuters, predicts that "Japan will shoot itself in the foot – again" and "will probably sink back into recession".

Nonetheless, this is something of a minority view, says Citywire. Indeed, Japan is "probably the most widely tipped region to outperform in 2014" as the government stimulus continues to push the yen lower and offer assistance to exporters. There may not be a repeat of last year's "thumping returns". But the outlook remains strong.

Old economies: US vs Europe

"2013 was good for the eurozone, largely because nothing much happened and financial markets interpreted no news as good news," says Ronan Keenan on GeopoliticalMonitor.com. Stock markets across the continent rebounded, with Greece and Ireland among the top performers, notching up gains approaching 35 per cent. But growth across the zone in 2014 is expected to be minimal, major structural issues remain, and the spectre of deflation continues to haunt. The US economy, by contrast, continues to offer "grounds for optimism", says the FT, and should be strong enough to withstand any shock from Fed tapering.

Does that make US stocks better bets than European ones? Not necessarily, says the Times. Indeed, following last year's outsized performance, many argue that shares look overpriced. Brian Dennehy of Fundexpert.co.uk, says that on one measure, the Shiller price/earnings ratio, the market is now valued as highly as it was months before the 1929 Wall street Crash. "The message is to proceed with care."

Meanwhile, the negative sentiment surrounding the eurozone doesn't change the fact that many European companies are performing well," says Patrick Connolly of wealth manager, Chase de Vere. And valuations remain cheaper than in most other parts of the developed world.

Could gold make a comeback?

Gold funds took a huge beating in 2013: seven of the ten worst performing UK funds were gold-based according to Hargreaves Lansdown, including sector behemoths like BlackRock Gold & General (down 47.9 per cent). Could 2014 see a comeback? Don't bet on it, says David Stevenson in the FT. While improving global growth could see other commodities steam ahead again, "I predict that gold will be below $1,000 an ounce by midyear."

A version of this article appears in the 11 January 2014 edition of The Week