Will 2014 be a continuation of 2013? Most investors believe that this will be the case. Consensus suggests that equity markets will rise, although not at the same rate as was the case in 2013. Bond yields, particularly in the US, are expected to rise as economic growth improves whist inflation is expected to remain low in the US and eurozone whilst rising marginally in Japan. China will grow, albeit at a slow rate whilst Japan will continue with its policy of aggressive reflation. In many ways 2014 sounds like a goldilocks year.

Yet, as we all know, financial markets follow their own path. In this report we set out some of the macro factors that may well impact markets in 2014 and look a little more deeply at valuation levels. Our broad conclusion is that whilst the macro environment is more supportive of equity prices in developed markets, we are approaching something of an inflection point where excess liquidity will need to be drained from the banking system, particularly in the US. In this regard we see recent developments at the Federal Reserve as interesting. In essence, the Fed is adjusting the overnight repo system to allow financial institutions to place unlimited funds on an overnight basis. Why is this single development of particular interest? Up until recently the amount placed by banks was limited in each area. When this facility is fully implemented as a key tool of Fed policy and there is no limit on usage per counterparty, the rate offered is expected to set a harder floor under money market and repo rates and provide the FOMC and New York Fed as its agent with the ability to exert greater control.

Whilst corporate earnings in the US are expected to rebound in 2014, higher interest rates in the form of a normalised yield curve coupled with lower levels of excess liquidity are likely to act as a headwind to equity prices.

We are pleased to report that your fund has enjoyed a productive 2013. Our focus as we move into 2014 will, as always, be to position the portfolio in such a way that promotes the achievement of the stated investment objective whilst specifically focussing on the management of downside risk. It is this latter endeavour that is the most demanding given the unprecedented level of central bank intervention and concomitant channels for risk transfer.