Batty says the US economy “is not growing fast enough” and is concerned over the prospect of fiscal and monetary tightening coinciding. The Federal Reserve is scheduled to stop the expansion of the monetary base via QE next month, just as the debate over the US’s fiscal health intensifies.
"US fiscal policy is the next gorilla in the room", he says. "Just as the effects of fiscal policies, such as tax breaks and auto subsidies, start to wane, you’re getting the prospect of further tightening measures. Market rates are up a bit and mortgages are off a cliff. In this context it seems premature to withdraw liquidity."
“It is clear that that the US economy is not robust enough. The danger is that growth in the second half of the year doesn’t come through. If growth really disappoints then QE3 is a possibility”.
More positively, Batty suggests that expectations of a slowdown in US and European corporate earnings are misplaced. He cites factors including firms’ continuing ability to control labour costs – and the absence of any notably higher wage settlements – and suggests that higher input costs need not sound the death-knell for profits.
Oil prices
“Higher oil prices are positively correlated to aggregate earnings”, he says, suggesting that costs can be mitigated by higher prices and pointing to the fact that the global stock market is overweight oil stocks and revenues when compared to the wider economy.
“Our research suggests a 10% rise in oil prices produces a 1% increase in earnings. The one caveat would be an oil price shock that caused prices to rise sharply over a short period of time.”
The SLI house view remains neutral on equities as an asset class, however, preferring the opportunities offering by property and corporate bonds. The house view has moved overweight investment grade corporate bonds this month.
“We prefer the extra yield offered by corporate bonds”, said Batty, who adds that “property is a good inflation play as rent levels continue to increase”.
Both sectors are closely linked in with the cash generation of the corporate sector, Batty noting that firms first pay rent, then bond coupons, and only later consider how best to utilise any excess cash.
Batty sees other headwinds for equities, too: “the problem with equities is the policy risks. You can get battered around by policy requirements. We are also worried about the role of capital growth as a chief driver of return. I don’t think you can rely on that as a big component of total return”.
