Investment

The weather with you

Signs of improvement in the markets offer some cautious promise for investments. Tracy Collins provides an overview of global markets and identifies some of the strengths and weaknesses for investors

The past three years have seen the worst global economic crisis since the 1930s. However, the extraordinary stimulus initiated by western governments in 2009, by way of aggressive fiscal and monetary easing, paved the way for 2010 to turn out to be perhaps a surprisingly good year for investors, given the wide swings in sentiment the year entailed.

Since the bottom of the market seen in March 2009, asset classes across the board have staged a solid recovery. Investors who bought equities, commodities, precious metals and bonds any time in 2009 have enjoyed considerable profits throughout 2010, providing they held their nerve.

The past year did not come without considerable volatility, though. 2010 saw markets whipped about time and again by macroeconomic concerns, stimulus measures, money printing, with investors switching rapidly from risk-on to risk-off mode. It seems likely that 2011 might prove to be a similarly rocky ride.

Outlook uncertain
Despite the significant recovery that investment markets have posted, we enter 2011 with the economic and investment environment far from certain. Policy-makers in the developed world have struggled to deliver a sustainable recovery and the impact of the unprecedented fiscal measures they have taken since the crisis began three years ago is still largely unknown.

Despite the many uncertainties, investors are hopeful that this year might prove to be as equally rewarding as the last. Global equity and commodity markets rallied strongly in the last quarter of 2010, and so far have continued that strength into the New Year, buoyed by the latest rounds of positive macro data which seem to suggest that the faltering recovery experienced in the western world last year might finally be starting to solidify. Fears of a double-dip recession, talk of which was rife during the summer of 2010, seem finally to have receded.

Recent economic data have fuelled that optimism. Manufacturing data from around the world indicate robust growth, and at home the latest UK PMI data confirm that our manufacturing sector is the healthiest it has been for 16 years: a surprisingly positive piece of news considering the negative headlines so dominant in these times of austerity.

Even the troubled Eurozone’s recent data confirm that, the peripheral countries excepted, growth is largely on track. It is well documented how German manufacturing has profited tremendously from the weak euro. The IMF forecasts global growth this year of 4.2 per cent; a healthy growth rate from which many multinational companies can expect to benefit.

Still, the recovery must be considered in context – without the extensive stimulus programmes implemented around the world, global growth would be considerably below where it is now. Let’s not forget that what has taken place is one large financial experiment. While governments have left us in no doubt that they will do all they can to avoid Japanese-style deflation, so much money has been printed and pumped into the system that the debt overhang is alarming. Governments in the developed world are performing a very fine balancing act.

And elsewhere
In other corners of the world, the picture could not be more different. If the growth numbers in the west are finally beginning to show signs of a sustainable improvement, this is largely because emerging economies are firing on all cylinders.

Industrial production and consumer growth in the emerging world have been staggering. While we have become accustomed to double-digit growth rates in China, it is remarkable to see many other emerging economies – India, Brazil et al – also producing Chinese-like expansions, driven by robust manufacturing and retail sectors.

Blistering growth does not come without challenges, though, and inflationary pressures in most emerging economies are mounting. Since most emerging market currencies are pegged to the dollar, they import US monetary policy de facto. Favourable demographics, the ability to leapfrog generations of technology and increase capital intensity and labour productivity, provide sufficiently positive growth dynamics in themselves.

Add near-zero interest rates to this, and it is akin to pouring fuel on a fire: convergence has become hyperconvergence. Real interest rates in some emerging economies are already negative; all paving the way for potentially serious growing pains in the form of asset bubbles and soaring inflation.

Mixed forecasts
In a two-speed world – hyper-growth in the east and fragile recovery in the west – where are the best investment opportunities? Undoubtedly, serious risks remain and investors must be highly selective in their investment choices. The Eurozone sovereign debt crisis is yet to be resolved, there are deep-rooted concerns over the longer-term consequences of quantitative easing, and whether such loose policy will eventually cause much higher inflation in the west than was ever intended.

Equities continue to be the preferred long-term asset class. The near-term outlook for government bonds remains unattractive, with the medium-term picture perhaps more mixed, as renewed worries about solvency and inflation could exert upward pressure on yields.

Eventual rising interest rates and illiquidity mean that investors should be cautious on real estate, although there could be some good select opportunities in global REITS, which offer more liquidity and the opportunity to invest in pockets of the world where market conditions are more positive.

Equities, though, with their direct link to economic growth, provide perhaps the best protection against inflation. Company profits are in good shape currently as are their balance sheets, thanks to the cost-cutting and corporate restructuring that has taken place over the last two years. And due to increasing profits, equities are actually cheaper than they were this time last year despite the marked recovery in stock markets (the FTSE World’s forward P/E is below 13x, versus more than 14x a year ago, for example). Dividend yields are also higher than most government bond yields, and normally this indicates an opportune time to be buying equities.

Given the superior growth prospects, investors should remain positive on the wider investment case for emerging markets, however not by investing directly in emerging market stocks: from a valuation perspective, large multinational firms that are successfully selling their brands, their intellectual property and technology into the emerging world. The strategy of holding multinational companies able to generate remarkable export-led revenue growth from the world’s fastest growing regions has been a successful one.

Tracy Collins is an investment manager in the Charities Team at Sarasin & Partners. Tracy can be contacted on tracy.collins@sarasin.co.uk. 

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