Commentary
So where is the market going from here?
by Nigel Crawford, executive director, Quilter, head of the Belfast office A
fter the last couple of years many who thought they were investment experts have had to
have a rethink. Equities that looked cheap two years ago got much cheaper when the banking crisis
began and some stockpickersʼ predictions proved to be way off the mark.
Fear that the world was going to implode led to heightened risk aversion and in general confidence in the stockmarket waned significantly. But the world did not end and markets recovered. Many companies have had to have a hard look at themselves and have taken this as an opportunity to put their houses in order. A number of these quality companies are now much leaner and forecasting continued growth in profits and dividends.
So what have we learnt and who should we let invest our money?
I think the most important lesson has been donʼt put all your eggs in one basket! If you had invested your money in a small number of direct equities you could have suffered significantly. Clients should look for a discretionary manager who has a distinct and robust investment process and asset allocation model. Let the investment manager spread the risk across a number of asset classes and geographical regions. Sound asset allocation should deliver solid returns in the longer term and diminish the stock specific risk that many investors have suffered.
So where is the market going from here? Although the recovery in developed economies has been relatively modest so far, stock markets continue to experience a ʻVʼ shaped recovery and the pattern is proving remarkably similar to previous cycles. Policy measures combined with liquidity from central banks remain supportive, even if much of the stimulus in the developed world has been targeted at the financial sector. Unlike increasingly indebted governments, companies were quick to reduce costs and, with the obvious exception of banks, their strengthening financial position means corporate profits are expected to rise 30 per cent this year with record margins maintained and large cash reserves built up. So what happens next? Clearly, withdrawing the stimulus prematurely might result in another downward lurch but, conversely, excessive liquidity could cause inflation to pick up. While governments in developed economies are reluctant to bring expenditure more into line with sustainable output, repeated stimulus reduces the long‑term trend rate of economic growth and global competitiveness. The most likely outcome is therefore ʻmuddling throughʼ with the option of renewed measures in 2011 if the recovery suffers a serious setback.
Recent economic data have been mixed but there have been more upgrades than downgrades to growth forecasts. Those for Asia and the US continue to improve, with Europe remaining the laggard. The inflation outlook for the developed world is relatively benign although there is a divergence between declining expectations for the US and an increase for the UK. It seems probable that the
economic uptrend will continue and, perhaps, even gather pace ‑ as unemployment peaks, consumer confidence rises and inventory de‑ stocking nears an end. Uncertainties, however, remain, notably the liquidity cycle given the frequent incremental reversals in policy stimulus although the authorities are treading warily even in the higher growth economies. China compensated for the global export downturn by implementing a four‑pronged package encompassing monetary, credit, exchange rate and fiscal policy but, with this starting to create growth ʻproblemsʼ, bank reserve requirements have been raised and lending reined in.
The latter could still rise 15‑20 per cent this year as part of longer‑ term plans to invest in infrastructure and facilitate urbanisation which raises concerns about asset ʻbubblesʼ. Residential property is an obvious example because if China is to achieve an urbanisation rate similar to other developing economy models over the next decade, this will require new housing for an additional 200m people. India, with near double‑digit inflation, faces rather different growth problems and here interest rates are rising.
Moderate growth in the developed world means that forward interest rates have barely moved in recent months. Some emergency stimulus measures are either expiring or being withdrawn but these moves are largely symbolic. Overall, liquidity is declining very gradually and remains supportive.
The impact of fiscal deterioration
Another uncertainty is the impact fiscal deterioration in the developed world will have on funding. While attention has focused on the volume of debt, other factors such as the private/public split, currency denomination and foreign versus domestic ownership are also important. Although there are substantial amounts of private and public sector debt to be rolled over, a financial crisis followed by deleveraging usually proves disinflationary. One of the key issues is therefore the ʻpriceʼ demanded by investors and the impact this has on the cost of capital in general. Where there is perceived to be policy weakness, as in the case of Greece, investors seek higher compensation so it is interesting that 10 year UK gilt yields remain at the lower end of our estimated 3.75‑4.75 per cent range. Companies are also active issuers of bonds but corporate spreads in particular on non‑financials, are close to a cyclical low which suggests that further outperformance against sovereign debt is less likely.
Equities are clearly no longer the bargain they were a year ago and have anticipated much of the forecast improvement in profitability but, with commodities again looking over‑extended, commercial property grappling with funding issues and bonds marking time at best, shareholders should be adequately rewarded for the risks over the longer term.
With the UK general election resulting in a hung parliament, there were concerns that the crucial decision‑making required to tackle the deficit would be put on hold. However, the new coalition government is already working together to reduce the deficit to more manageable levels. This should encourage the markets and we will watch developments with interest.
www.businessfirstonline.co.uk 23
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