Buckle up! 2014 will be a bumpy ride

Get ready for a volatile year. Last week's stock market gyrations and currency swings are a sign of things to come as central banks wean investors off cheap money.

Financial experts at the World Economic Forum in Davos were cautiously optimistic about the outlook for growth in 2014, but the beginning of the end of post-crisis emergency financial support will be bumpy.

The Dow just had its worst week since 2011. And emerging market currencies got hit hard as investors fled riskier assets.
Investors were troubled by signs of weakness in China's huge manufacturing sector and a looming default in the shadow banking system. Expectations that the Federal Reserve will continue to pull back monetary stimulus pushed things along.
"I hear way too much optimism going forward -- we're going to be in a world of much greater volatility," said BlackRock CEO Laurence Fink.
Related: Cry for me Argentina? Peso plunges
Investors had been encouraged by "good, consistent" central bank policy around the world in recent years, he said. But the next impetus for growth would depend on governments in China, Japan, the U.S. and Europe delivering on promised economic reforms.
"That troubles me, because there has been great consistency of governments dragging their feet," Fink said.
Monetary policy is already beginning to change in the U.S. and U.K., in response to stronger growth and falling unemployment.
The Federal Reserve has begun to "taper" its purchases of government bonds, and some analysts predict the Bank of England will raise interest rates as early as the fourth quarter.
Bank of England Governor Mark Carney said there was "no immediate need" for an increase in the cost of borrowing, and that when it comes, the process will be gradual.
But the return to more normal levels of market volatility would feel worse than it is, coming after an extended period of calm, he said.
Related: India headed for 8% growth

 

Goldman exec: World needs faster growth

The International Monetary Fund upgraded its forecast for world growth on Tuesday. It warned that the outlook would depend on the impact of the withdrawal of central bank support.
"This is clearly a new risk on the horizon, and it needs to be watched," IMF Managing Director Christine Lagarde said.
The flow of money back to the U.S. and other developed economies would not affect emerging markets uniformly, she added. Investors would differentiate based on political stability, commitment to reform, and signs of financial weakness.
"The risk is there, but well managed emerging markets will be able to cope with it," said Montek Ahluwalia, deputy chairman of India's planning commission.
Fink said too much attention was paid to the actions of the Fed and other central banks, and not enough to the reforms needed to respond to the massive technological changes that are destroying jobs.

Hedge funds get a reminder of how it feels to lose

By the time last Friday afternoon was finally over, managers at even some of the most successful hedge funds felt like crawling into a hole.
While the S&P 500 declined only 2.6 percent last week, the move came as a shock for many on Wall Street, which had not been hit so hard since the summer of 2012.

The pain was far worse for those exposed to emerging markets, where many hedge funds have ventured in search of bigger returns. Stocks in Turkey, for instance, are down 15 percent in U.S. dollar terms so far this year and nearly 50 percent from their peak last May.
Even with markets looking calmer Monday morning, last week's rough ride reminded hedge funds of a challenge they haven't faced in some time: Generating positive returns in a losing market.
With the S&P 500 rising every year since 2009, it has been possible to generate decent returns without keeping up.
Take 2013. The HFRI Equity Hedge Index, which tracks stock-focused funds, rose 14.6 percent while the S&P 500 rose 29.6 percent. Similarly in 2012, the Equity Hedge Index gained 7.4 percent, compared with a 13.4 percent rise in the S&P 500.
Such a performance was probably enough to please many investors who have entrusted their money with hedge funds. The thinking is that hedge funds can deliver stable returns in any market, even if they lag a bit when stocks soar.

(Read more: Is P&G the right gamble in the selloff?

But the real test comes when markets swoon. While it helps to have short positions in place to protect against a broad selloff, funds still need to make some very smart bets to generate gains in a falling market. Just look at 2008, when the Equity Hedge Index fell 27 percent percent versus the 38 percent decline in the S&P 500.
The good news: Any panic selling could throw up opportunities. Indeed, some hedge funds say they would welcome a further selloff so they can buy stocks that have been on their shopping lists but remain too expensive.
But succeeding in a choppy market requires both the ability to pick good ideas and time them right. By the end of 2014, it may be clearer which funds have real talent.
Indeed, that could be a positive for investors who have placed their money with hedge funds and paid them handsome fees in the last few years. While the hedge fund industry slimmed down and fees fell after the financial crisis in 2008, assets under management have returned to record highs. It may not be the worst thing for investors in hedge funds to see managers put to another test.

—By CNBC