“That base case is also the best case, and not just because everyone is expecting it. But no one should take anything for granted,” she said.
In a conference call outlining her key themes for the year, she noted that the Bank of England’s (BoE) forward guidance on both the unemployment rate and consumer price index (CPI) proved woefully inaccurate.
Her view, though, is that it is better to have imbalanced growth in the UK than no growth at all, although there is a long way to go, with actual real GDP growth well below trend levels. “The UK needs investment and real wages to recover, with fewer jobs,” said Flanders.
As for Europe, Flanders believes it is past the worst, but it is not “happy days” just yet. The US, meanwhile, is showing a stronger story driven by housing and the consumer: “The big shared force for optimism in Europe and the US is that there are fewer fiscal headwinds.”
She pointed out that many European countries are well on the way to reducing their budget deficit.
Most countries are growing, and money is likely to stay extremely cheap for the foreseeable future, in Flanders’ view. However there are also some risks, in the form of three potential scenarios.
“Faster growth with no sign of inflation would lead to worries about the rate path, but the base case for equities would remain intact. Faster growth with fears about inflation and the supply side would see more risks for fixed income and possibly more concern around valuations.”
Stalled growth, on the other hand, would revive deflation worries, which would potentially be good for core fixed income but bad for everyone else.
The broad implications for investors are that they should stay overweight equities, but rebalance, said Flanders. A greater focus on valuations suggests the best opportunities are outside the US, but selection is the key.
“The base case supports US equities, but they’re no longer cheap. There are potential opportunities in Europe, but it depends on a recovery in earnings – another year of earnings and valuations moving in opposite directions seems unlikely.” Many emerging markets, meanwhile, are starting to look cheap, but still scary, in her view.
In fixed income, Flanders said a normalisation of rates poses challenges for core fixed income. “High yield and European periphery [fixed income] can protect returns in rising rate environment, but less than 2013.” Finally, investors should not cheat on diversification if security is important to them. “If deflation fears are even half right, it could pay off.”
