Investment Outlook
Investment Outlook - October 2011
Economic indicators have continued to disappoint of late and with this growth prospects across the globe, particularly in developed markets, have been further scaled back. Much has changed over the long and somewhat dismal summer. Previous expectations that the burgeoning eurozone sovereign debt crisis would be addressed and contained have so far failed to be met and with no credible plan yet in place, there is concern that a potentially manageable situation will be left to fester and spread. Meanwhile, hopes that the US would assume its role as a bellwether of global growth were seemingly dashed as further rounds of quantitative easing (QE) and President Obama’s Jobs Act failed to meet expectations and quell fears of a renewed downturn. As at the quarter end, the global economy looks to be in a gloomy state, its outlook challenging. Markets, sentiment and confidence have all reacted accordingly and despite many attempts to rally within the quarter, equity indices around the world are underwater both quarter and year to date. Yet, a private sector flush with cash and seeking a home for its balance sheet reserves, provides some glimmer of optimism and with it attractive investment opportunities.
The troubles in the eurozone continue to attract much attention as financial market turmoil, fiscal austerity, tumbling business and consumer confidence levels and weaker global demand take hold. Hope that northern eurozone states such as Germany, Europe’s ‘powerhouse’ with its current account surplus and export-oriented economy, would weather the storm and provide some stability to its southern counterparts has also dwindled as Chinese, Russian and US demand for its industrial and chemical goods has retrenched and fears of contagion have stymied its markets.
Greece persists as the region’s bête noir but the spotlight has now been turned more firmly on Ireland, Italy, Spain, Portugal and even France. Frustratingly, fears of contagion have tarred these troubled yet still solvent economies with the same brush but many, particularly in the case of France, are in a significantly stronger position than Greece and the eurozone as a whole is expected to avoid recession through to 2012, returning to stronger growth thereafter. In these very sentiment-driven markets, respite for the region in the short term lies in the hands of politicians in taking decisive and credible action - whether that be a recognition of the need for Greece to default and exit the euro or a concerted decision to delay and allow time for an orderly restructure. The current vacillation, however, is not the answer.
In the UK, with the threat of recession looming and in an environment where monetary policy is unable to provide further stimulus, the administration’s commitment to fiscal austerity has strengthened the case for a resumption of the QE programme. This has been met with both optimism and criticism, with those in the latter camp pointing to a lack of success with earlier programmes and proponents claiming that additional flows of capital, through the purchase of bank assets, will continue to boost asset prices and nominal demand. With consensus seemingly still cautious on risk assets, and with equity markets appearing oversold at current levels, renewed QE may take some time to bite, prolonging support for fixed income markets in the short term despite the presence of inflationary pressures.
To date, the UK government has taken a more focussed attitude towards economic prudence and its reward was improved confidence in both the market and sterling. Well and truly out of the honeymoon period however, and faced with rising unemployment, falling living standards and an overly inflated and indebted public sector, political party management and confidence building from here will be hard and any further bouts of civil unrest will be unlikely to boost confidence in the market or sterling.
Previous expectations that US GDP growth would accelerate in the second half of this year appear to be dashed. Initially consumed with concerns over the US budget deficit and default, President Obama’s attention has since turned to job creation in a bid to prevent the economy from dipping into recession (and save his faltering premiership). Whilst the $450bn plan was initially well received, rhetoric and policy ambiguity continue to cloud the President’s agenda and his approval rating has since fallen. At a time of rising unemployment and housing market fragility, such policy uncertainty is likely to knock confidence further, deprive markets of stability and, with a Republican majority in Congress, see little of President Obama’s legacy survive.
In contrast, markets in Asia provide some cause for optimism. Weakness in the western economies has and will most likely take its toll on Asian growth prospects in the form of declining confidence and softening export orders. Nevertheless, with ample scope to use policy to boost growth in the event of any downturn, coupled with an East-West wealth differential, the emergence of new trade corridors and domestic demand resilience, the region appears well equipped to maintain high and sustainable growth over the coming years. The question for Asia, and in particular China, is whether a scaling back of growth will result in a ‘hard’ or ‘soft’ landing. With inflation now under control across Asia, and in China falling back, there has already been a shift towards more pro-growth policy initiatives and this should ‘soften’ the landing and bode well for markets going forward.
In light of the somewhat tumultuous conditions that have prevailed, volatility in currency markets has increased and the task of forecasting short-term currency moves, whilst never easy, may prove almost impossible. The recent decision by the Swiss government to deflate the Swiss franc by pegging it to the euro, hobbling one of the last remaining ‘safe havens’, may provide some support to the euro in the short to medium term. Whilst QE programmes in the US and UK are hoped in the long run to strengthen their domestic currencies, the current uncertainties may result in a ‘race for the bottom’ with the US dollar strengthening to some extent by default. Asian currencies may strengthen from here but with export demand already under threat, currency wars and trade protectionism cannot be ruled out.
Fixed income markets have performed well this year and yields have fallen as a result of economic uncertainty. These markets are now looking expensive and, with inflation eating into real returns, further strength from here is likely to be unsustainable in the long term, albeit yields may continue to fall in the short term. A lack of safe haven options and the very low level of interest rates across western economies continue to lend support to equity markets however, global earnings revisions have accelerated over the last month, particularly in the more cyclical areas of the market, and this could continue to unsettle markets. Nonetheless, equities arguably offer an interesting risk-reward trade and many now at increasingly opportune entry points. From here, we see the strong getting stronger.
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