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The Investment Outlook - 8th September 2009
The Investment Outlook
8th September 2009
In Summary
• We are still suffering a recession that arose because too much leveraging caused all the liquidity problems that came to a head in the second half of last year. Now the news is becoming less dramatic and there are signs that the global economy is beginning to settle down again. The big question is whether or not the “green shoots” are firmly rooted.
• There is greater optimism about economic recovery, but this will not be helped in the UK by the enormous fiscal deficit which will mean cuts in public spending.
• Many investment managers and analysts are wary about the trailing effect of unemployment and how soon the banks rebuild their balance sheets and actually start lending again. Housing might also have further to fall. These factors could cause a “W” shaped recovery.
• Interest rates are expected to stay low for this year and maybe rise again towards the end of 2010. Low rates would also have the effect of keeping Sterling at a competitive level.
• It remains to be seen how effective Quantitative Easing will be and will it cause longer term inflation? That would cause problems, but inflation would also have the effect of reducing, in real terms, the enormous levels of government debt. For the time being though, it is deflation that poses a greater threat to economic recovery.
• At some stage, there has to be a recovery. It appears to have started in Asia, but it is the time scale and extent of it that is debatable in the UK. It’s going to be a slow climb and it won’t suddenly become apparent that the lights have been switched back on. At least a weak recovery should help to curb the inflationary pressures. Equity markets have continued to recover, but could become range-bound at some level until there are clearer signs that the economy is recovering.
The Investment Outlook in full
The economy has slowed, to the extent that GDP in the UK has fallen by 5.6%, but there are some more positive signs, such as the banks starting to make money again and rebuild their balance sheets. Unfortunately, the UK economy still faces many problems and is in a worse position than other countries in what remains a serious global recession.
The UK economy is not diversified enough and fiscal policy is a worry, given that a budget deficit of £200bn has to be met this year – and again next year as well.
Interest rates have probably fallen as far as they can go and inflation is also plummeting – to such an extent that there are concerns about deflation. However, the Governor of the Bank of England, Mervyn King, believes that support for the economy remains necessary and so interest rates are likely to remain “lower for longer”. The government is going to face a difficult balancing act between low interest rates to boost the economy and high yields to sell all the gilts that will have to pay for the quantitative easing. Meanwhile, unemployment is rising and so consumption could fall.
The US economy is thought to be pulling out of recession and the UK is expected to follow in the final quarter of this year, but there could well be further problems ahead.
House prices have been the subject of speculation that the fall in prices is coming to an end, but there are conflicting views and prices could well fall again if unemployment continues to rise.
The UK is struggling because of the fiscal deficit and the fact that too much faith has been placed in over-optimistic growth estimates. The consequent severe cuts in public expenditure will also suppress recovery. A competitive currency is required to help rebuild a more diversified economy, which will take a few years.
We have enjoyed a stock market rally, but the markets might still have to face more economic reality. That is not to say, though, that there aren’t some excellent opportunities for long term investors.
There has been much talk of the “green shoots of recovery”, but it is only in Asia and the emerging markets that the growth story might resume. A slow, gradual recovery seems to be the best that can be expected elsewhere, although America might be ahead of the UK and Europe. It is encouraging that manufacturing industry is showing signs of recovery, but unfortunately not in the UK. Company profits, particularly in the US, are holding up well but this is more due to cost cutting than sales and, again, the consequent redundancies could be another cause of further setbacks in the future. Although there are signs of a recovery, it is unlikely that it will be a normal one.
Equity fund managers continue to look to invest in companies with strong balance sheets, visibility of earnings and good cash flow. Dividend cuts have now started and it remains to be seen how long they will last. The recent recovery of equities has been encouraging, but markets could well become range bound as they wait for clear signs of the end of the recession.
As investors look for income, equity income funds should do well. Value stocks are likely to become popular for the dividends they yield and this should also bode well for the funds from our chosen passive manager, Dimensional, which have a value emphasis.
At these levels, equities must be good value. With attractive valuations, cash building up waiting to be invested and equities yielding more than gilts, there are many indications that they will perform a lot better over the next ten years, than they have done over the last ten. Fund managers are now able to find exceptional value in good companies which will offer good returns in the years ahead, but the equity markets might not yet have realised how long it will take to rebuild the UK economy and market volatility can be expected.
Gilts have benefited from a “flight to quality” over the last year and have probably become over-priced and low yielding. This has been further caused by the recent programme whereby the Bank of England has purchased long and medium dated gilts, which rallied accordingly. It is slightly ironic, though, that whilst the Bank of England is presently buying gilts, the Treasury will soon be selling them.
Corporate bonds, particularly investment grade, are much more attractive, but with the attendant risk of defaults, which could well increase depending on the length and depth of the recession. However, the government’s quantitative easing programme will help to underpin the default risk and it is generally thought that the fixed interest markets are pricing in an over pessimistic allowance for this. Investment grade corporate bonds offer a unique opportunity to lock in to yields which are attractive in the current low interest rate environment.
Whilst there are no strong views that property is poised for an imminent recovery, yields are becoming attractive relative to cash and gilts and the weaker pound is making it attractive to overseas investors. It is likely to be next year before there is a sustained recovery in the property markets
These views might be considered cautious with regard to all types of assets, perhaps with the exception of corporate bonds, but the long term effect could be much more positive over the next three to five years.
At a time such as this, it is important to review your circumstances and needs relative to your attitude to investment risk. Russell Ulyatt offers fee-based, impartial advice from a professional firm that you can trust.
Give us a call on 0115 9075100 if you wish to review your investments.
This is an investment commentary which should be viewed as providing general information rather than investment advice.
Any figures mentioned in this article should only be considered to be a current guide.
Any opinions expressed are intended to be a consensus view from a wide range of investment information.
The value of investments can go down as well as up and levels of income taken from investment funds may fluctuate and in certain circumstances might reduce the value of the underlying capital.
