A year ago, Candace Browning, head of BofA Merrill Lynch Global Research, predicted that “a muddle-through scenario in 2013 seems most likely.” She was right. Many far more dire forecasts — the disintegration of the euro zone, a hard landing in China, a fiscal crisis in the U.S. — turned out to be just plain wrong.
“Macro frustrated the bears, but there was plenty of price action in asset markets to spur the bulls,” Browning says. “Gold prices have fallen 26 percent — the most since 1981 — U.S. equities finally broke out of a 13-year trading range to hit new all-time highs, and the greatest bull market in bonds ever came to end as the ‘Great Rotation’ shuffled out of the shadows of 2012 and into the limelight of 2013.”
In an environment rife with anxiety, speculation and rumor, portfolio managers frequently sought counsel from the sell side to help them understand everything that was happening — or not happening. Throughout the year Institutional Investor asked these investors and other buy-side professionals to tell us which of their sell-side peers were proving to be most helpful. The results of II’s 12 annual research team surveys were published separately, but when the totals are aggregated, Bank of America Merrill Lynch finishes in first place on our Top Global Research Firms roster for a third year running — and by a wider margin than ever. It captures 257 total team positions, 21 more than last year and 47 more than J.P. Morgan, which returns in second place despite losing four spots, leaving it with 210.
Deutsche Bank’s losses are far more dramatic. The German financial services firm manages to hold on to third place even though its total falls by 25, to 168. Morgan Stanley, again at No. 4, claims 154 positions, one fewer than in 2012.
Credit Suisse’s total is unchanged at 119; nonetheless, it jumps from seventh to fifth, its upward momentum boosted by declines at Citi and UBS. Those firms shared the No. 5 spot last year but drop to sixth and eighth place, respectively. Citi’s count is down by 16, to 113, while UBS’s slumps by 26, to 103.
BofA Merrill is the only firm in the top ten with more total team positions this year than last. It claims first place in three of the 12 rankings: the All-Asia, All-India and Emerging Europe, Middle East & Africa research teams. J.P. Morgan matches that feat, topping the All-America, All-America Fixed-Income and All-Europe Fixed-Income research team rosters. Six firms lead coverage on the other six country and regional teams: BTG Pactual, Brazil; China International Capital Corp., China; Deutsche Bank, Europe (equities); Itaú BBA, Latin America; Nomura Securities Co., Japan; and Sberbank CIB, Russia.
What can money managers look forward to in the new year? “We believe the investment regime will change in 2014 from the high-liquidity, low-growth regime that has characterized the post-Lehman era to one of higher growth and lower liquidity — in that order,” believes Browning, who works out of New York. “Put simply, higher growth argues for another year of positive asset returns, while lower liquidity argues that the positive returns next year will be significantly less spectacular than in 2013.”
Thomas Schmidt, Browning’s counterpart at J.P. Morgan, holds a similar view. “We expect 2014 to be much like the second half of 2013, with better growth, subdued inflation and continued interest rate normalization,” he says. “But certain countries are much closer to an exit from easy money than others, driving relative bond performance.”
Few issues affected world markets over the past year as much as anxiety over the U.S. Federal Reserve’s plans to cut back its $85 billion-a-month bond-purchase program. Despite strong hints that the Fed would begin winding down its operation in September, that didn’t happen. But it will.
“We do not expect tapering to have as negative an impact on markets as the threat of it did during the early summer of 2013,” Browning says. “Why? Because the Fed, and other central banks, will use ‘forward guidance’ to reduce market fears of higher interest rates and because those fears will also be alleviated by the lack of inflation in the global economy.”
Bouts of volatility are inevitable, she adds, but as long as growth accelerates, inflation stays low and central banks maintain control over bond markets, the backdrop remains favorable for financial assets.
Debt markets haven’t done so well lately, notes Joyce Chang, who became J.P. Morgan’s global head of fixed-income research in December 2012. The firm ranks first in the aggregated totals for coverage of that asset class.
“This has been the worst year for U.S. fixed income since 1999, with year-to-date total returns at negative 1 percent,” she reports. “Every U.S. fixed-income sector produced negative returns except for high yield.”
The New York–based research director doesn’t anticipate improvement anytime soon. “We are forecasting lower returns for fixed income, ranging from 3 percent losses for U.S. Treasuries and municipal bonds to 4 to 5 percent gains for emerging-markets fixed income and U.S. high-yield bonds,” she says.
However, Chang believes the Great Rotation out of bonds and into equities is more myth than reality. “Overall supply-demand technicals remain supportive for fixed income, and institutional demand remains strong owing to structural changes to the fixed-income market and the lingering effects of financial repression,” she explains. “We do not expect spread widening in most markets, and we expect the primary calendar to remain strong.”
Specifically, she estimates the supply of U.S. high-grade bonds at $900 billion in 2014; U.S. high-yield bond and institutional loan issuance at $300 billion and $400 billion, respectively; emerging-markets corporate bonds at just under $300 billion; and municipals at just over $300 billion. “This is not far below the record levels of issuance we saw in 2013,” she notes.
Chang was among the first to tell investors that the Fed would not begin to exit quantitative easing until 2014, and she maintained that position even as more and more market observers insisted that cutbacks would start in September. She predicts that the central bank will begin scaling back in January and complete its asset purchases by the end of the third quarter.
“I don’t expect as much volatility because the market will begin to differentiate Fed tapering from Fed tightening, and this will play out more smoothly than in 2013,” she explains. The Fed’s exit and supply-demand imbalances should push ten-year yields to 3.25 percent by mid-2014.” (In early December the yield was 2.88 percent.)
Taper talk continues to rattle emerging markets, which were pummeled when U.S. policymakers began hinting that the QE end was nigh. The pace of the reductions will be very much on the minds of portfolio managers in 2014, according to Kingsmill Bond, chief equity strategist at Sberbank CIB. This year marks the first appearance atop the All-Russia Research Team for the Moscow-based firm, whose January 2012 acquisition of cross-town rival Troika Dialog has helped propel its research franchise in its home country and in emerging EMEA.
However, Fed action is only one concern weighing on investors in Russian equities. Another is the muted impact of reforms meant to jump-start growth. In early November, Minister of Economic Development Alexei Ulyukayev predicted that the nation’s economy would expand, on average, by only 2.8 percent per year through 2020 — well below the 5 to 6 percent target set by President Vladimir Putin — as stagnation tightens its grip. Sberbank’s Bond is even more pessimistic for the near term, anticipating real gross domestic product growth of just 2.3 percent in 2014.
Elsewhere, the panic selling caused by Fed fears has resulted in buying opportunities. “Our economic research team believes that investors have come to terms with tapering,” declares J.P. Morgan’s Schmidt. Going into the new year, the New York–based research director adds, “investors will be thinking about how the move from QE to rate guidance will affect markets after what we saw this summer, and they will assess whether emerging-markets assets are an opportunity after [recent] underperformance.”
Schmidt says there are other reasons to be optimistic. “We are expecting accelerated global growth with less fiscal austerity, accommodative monetary policy and limited headline and political risks,” he says. “Inflation will remain subdued, especially in the euro zone and Japan.” • •
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