As 2014 Dawns, Fortunes Hinge on Central Bankers

As 2014 Dawns, Fortunes Hinge on Central Bankers

Investors See Little to Shift Attention Away From Monetary Policy

TOM LAURICELLA

Jan. 1, 2014 11:40 a.m. ET

The new year kicks off much where 2013 began, with investors riding waves of money pumped into global financial markets by the world’s major central banks.Developed-economy stock markets posted double-digit-percentage gains as easy-money policies washed over concerns about growth in economies still hobbled years after the financial crisis.

For 2014, many investors see little on the horizon to shift attention away from monetary policy, even as hopes rise again that the U.S. economy is finally moving into a slightly higher gear.

“In being so aggressive, monetary policy tends to swamp everything else,” said Dennis Stattman, manager of the $59 billion BlackRock Global Allocation fund. Even in the U.S., where the Federal Reserve is set to trim its monthly bond purchases by $10 billion in January, “some kind of very easy money is going to be with us for a very long time.”

While the monetary policy fire hose has worked in favor of stocks and bonds, “it’s forcing investors to effectively make investment decisions on one thesis,” said Stephen Rosen, chief investment officer of the London-based $800 million Omni Macro Fund. “It’s a massive…concentration of risk.”

Thus far, however, that risk hasn’t been a factor. The Dow Jones Industrial Average posted 52 records on its way to a 27% gain in 2013, its best performance since 1995. The S&P 500-stock index climbed 30%, while Japan’s Nikkei Stock Average surged 57% for its biggest gain since 1972.

European stocks, too, posted gains well into the double-digit percentages. German’s DAX gained 25%, France’s CAC-40 rose 18% and Spain’s IBEX 35 climbed 21%.

By contrast, longer-term Treasury bond yields, which move inversely to prices, rose sharply in the U.S., as the Federal Reserve is taking its first steps to pare its unprecedented easing efforts. The yield on the 10-year Treasury note rose to 3.030% from 1.759% at end of 2012.

The selloff in government bonds has made corporate debt more appealing to investors, even though the debt issued by corporations doesn’t yield much by historical standards. But the selloff in government bonds sent broader measures of the U.S. bond markets down as well.

The Barclays U.S. Aggregate Bond Index lost 2%, its first decline since 1999.

Bond investors said returns will remain driven by central-bank easy-money policies.

“Central banks have become by far the most important buyers of government debt and that will still be the case in 2014,” said Jamie Stuttard, who manages $1 billion in bond funds at Fidelity Investments in London.

“If there was a risk to the outlook, it’s that the [economic] upturn ends up accelerating more, and that could be quite a bearish environment for bonds,” said Mr. Stuttard.

Jason Trennert, chief investment strategist at Strategas Research Partners, sees the monetary-policy dynamic, and thus prospects for financial markets, shifting in 2014 as to which central banks press harder on the gas pedal than others.

“Whatever sums the Fed might taketh away, it seems like the Bank of Japan8301.TO +3.62% and European Central Bank will giveth,” he said.

While much of the focus in 2013 was on the prospects for less stimulus from the Fed, as the year drew to a close more investors were keeping an eye on declining inflation rates across developed markets, especially in Europe. The lingering threat of deflation, they said, could result in monetary policy being looser than expected, fueling continued rallies in stocks and keeping bond yields relatively low.

In fact, some point to the Bank of Japan’s easing efforts, which helped send the yen down 18% against the dollar and 21% against the euro in 2013, as fueling disinflation elsewhere, particularly in Europe. By sharply pushing down the yen, the Bank of Japan is effectively forcing other currencies higher against the Japanese currency, which cuts into its trading partners’ economies by making Japanese exports cheaper.

“When you get a 25% movement in a currency, that’s not going to be the end of the story; it has consequences,” said Fidelity’s Mr. Stuttard.

Julian Le Beron, head of developed markets at Rogge Global Partners in London, which manages $57 billion, thinks this adds up to a relatively stable environment for bonds. Mr. Le Beron doesn’t expect yields to rise much higher from here. The yield on the 10-year Treasury note has likely shifted to a range of 2.75% to 3.25% from a 2.5% to 3% band, he said.

But William Stromberg, head of equity at T. Rowe Price Group Inc., which manages $647 billion, is in the camp of those seeing more sustained good news on the economy, which should help the prospects for stocks.

The downside, said Mr. Stromberg, is that stronger growth could cause some indigestion for financial markets as the Fed responds by tightening monetary policy. The result could be a “minicorrection” for stocks, but with interest rates generally staying low, inflation low and growth stronger, “we’re still in the sweet spot.”