The first quarter of 2014 had a few bumps in store for financial markets, yet in the end almost every asset class ended up with positive returns. Bonds performed well as interest rates declined and the US inflation rate remained below the Federal Reserve’s 2% target. US stocks recovered from January jitters to end the quarter in positive territory. Even emerging market stocks, buffeted by fears of financial instability in countries such as Turkey, Russia’s military adventurism in Ukraine, and weak economic data from China, finished the quarter only slightly down.
Despite the continued US stock market gains in the first quarter, the economic optimism that fueled last year’s stock market surge showed signs of fading. Weak housing market data helped more defensive sectors such a utilities and health care outperform the broader market.
The Russian stock market was pummeled in the first quarter as fears mounted that the country’s annexation of Crimea would crimp its economy and its ability to export natural resources. Russia’s troubles may have obscured a more important development, however: disappointing economic data in Japan and China led to a weak first quarter for Asian stocks.
The outlook for the Chinese economy is likely to be one of the key drivers of financial markets for the rest of 2014. For years bearish analysts have been predicting a financial crisis in the world’s second-largest economy, and declining property prices in China could be the start of a broader collapse that finally validates these gloomy prognostications.
Yet so far the Chinese government has overseen a fairly orderly decline in the country’s economic growth rate, and it has the capacity to stimulate the economy if it fears that trouble in the real estate market is spreading. Success in containing the fallout from the economy’s slowing growth would provide a boost for stocks around the world, particularly in China itself where valuations are very low compared to other countries.