A slow-growth environment in the developed markets will cause nervousness as cyclical ups and downs threaten reverting to recession. However, we take great comfort from the fact that there are still growth pockets in the global economy; most notably, in Asian and the emerging markets.
But more than this, it is important not to confuse the macroeconomic situation with what is happening at a company level. Despite the poor health of many developed market economies, many companies are in very good shape. Healthy balance sheets and diverse revenue streams mean that they are well positioned to weather the tough economic conditions in their domestic markets:
China
China is the world’s second-largest economy and it has extensive trade links to the rest of the world. Given its size and economic clout, any policy decision on the part of the new government will have global significance. And in light of the fragile state of the world economy, investors will be looking at what the new leaders will do to bolster domestic growth.
In our view, macro policy should remain fairly supportive though aggressive stimulus is unlikely; the government is still constrained by the negative effects of the previous credit boom.
This does not necessarily make the equity market attractive. It’s important to reflect that the MSCI China’s total return since inception (end Dec 1992) to end Sep 2012 was -11% (dollar terms, cumulative) vis-a-vis a 9%pa economic growth over same period.
US
In the US the effect of super storm Sandy and the outcome of the fiscal cliff debates mean there is still a significant level of uncertainty. Despite this, improvements in the housing market and hiring are providing some sustenance to the, albeit muted, US recovery.
It is important to remember that the fiscal cliff is in effect a self-imposed deadline. There is nothing to stop the US Congress taking a lead from eurozone leaders and agreeing an extension.
We continue to hold the view that some form of eleventh hour agreement will be made, although we are concerned about the longer-term implications of a hurried agreement. Above the political fray – and still looming ominously on the horizon – is the risk of failure to implement a credible and effective long-term plan to reduce the federal debt relative to its percentage of GDP.
We view this as the single-largest policy objective of the executive and legislative branches of government.
Europe
Fundamental differences over how to fix the debt crisis persist. Even if these were to be resolved, Europe still faces the prospect of a prolonged period of austerity and recession. Given weakened economies and lower earnings expectations, valuations now appear less appealing after a four-month rally in share prices.
However, like the US, Europe is home to some great global companies which are financially robust.
UK
Preliminary data showed Britain emerged from recession in the third quarter, helped by better-than-expected GDP growth that was bolstered by the Olympics and a lower base effect from an extra holiday in June.
However, an absence of any sustained or meaningful GDP growth is putting immense pressure on the coalition government. We continue to feel that stimulatory policy will need to be innovative to promote growth.
Emerging markets
Emerging economies are struggling to generate the kind of growth that has marked previous recoveries. Add to that, growing concern that the Federal Reserve’s latest round of quantitative easing may stoke inflation and trigger sharp gains in emerging market currencies which would make exports less competitive.
Investor sentiment is therefore likely to remain subdued, with the outlook susceptible to further economic or policy disappointments. Earnings growth for 2012 is also expected to be marginal in the circumstances. During such times, balance sheet strength and managing growth in a relatively conservative and disciplined manner become even more important.
Bonds
We continue to favour Asian and emerging market bonds, given the more favourable state of their economies and growth prospects generally when compared to developed markets. The case is really all about diversifying your fixed income exposure and income streams. And by doing so by lending money (buying bonds) from more financially secure countries or companies.
Just as in life you wouldn’t lend more money to someone who already has a mountain of debt, rather you would lend money to those who have little debt and are financially secure.
Property
Against the fragile and uncertain macroeconomic backdrop the outlook for UK commercial property total returns is relatively weak, but opportunities undoubtedly exist where a rigorous bottom-up approach to investment is applied.
There is a growing consensus that secondary property represents an opportunity in the long term, but there is sufficient risk in the short to medium term that we expect the polarisation of prime and secondary pricing to endure. Secondary valuations do not yet reflect prices realisable in the market, where appetite among buyers is only at high target rates of return.
Our forecast total return for the five years from September 2012 is 5% per annum.
