News from the City
Just as the fall in asset prices witnessed in 2008 was a direct result of the lack of liquidity in the markets, so the rise in asset prices in 2009 is largely a reflection of the significant amount of liquidity that has been pumped into the global economy by central governments. This action, agreed at the G20 summit of Finance Ministers and Central Bank Governors in March 2009, together with the application of near-zero interest rates, has been used with the objective of kick-starting the global economy.
To a large extent this two pronged approached has been successful and there is little doubt that a global recovery is underway.
What a change from the picture which was painted at the start of 2009, and yet there has been a marked contrast in the pace and shape of the economic recovery between ‘deficit' and ‘surplus' countries. This illustrates the global imbalances caused by western consumers who have become over-indebted, whilst China and other emerging and developing nations have targeted output and consequently sit on huge surpluses.
A global rebalancing will be required, with the surplus countries needing their people to spend more and save less, whilst here in the west we need to spend less and save more. However, many currencies in these emerging economies are pegged to the US dollar, and so to avoid the pendulum swinging too far with inflationary excesses in demand in surplus countries and a deficit of demand in deficit countries, there will need to be some gentle and measured adjustment.
It is perhaps a little surprising that a more positive market can exist next to a backdrop of rising public debt and government budget deficits. This has put many sovereign bond markets under pressure, of which Greece has to date received the most media publicity. Furthermore, there is genuine concern about what will happen when central governments cease the support measures which they have used to such effect, and which have helped to boost markets.
The key question is, therefore, how long will the current level of confidence in a strong recovery last? Most analysts are only prepared to make predictions until the middle of the year, and the current consensus is that the biggest threat thereafter is the possibility of a sovereign government defaulting on its debt.
What all of us are seeking is something akin to a ‘Goldilocks scenario' - not too hot and not too cold - where the global economy recovers and grows at a sustainable pace, and we receive steady returns on our investments. But life is more complicated than this, and for investment opportunities to exist there is a need for countries to be at varying stages of the economic cycle, with the corresponding impact that this has upon different asset classes at different times.
So what might 2010 have in store for us? At Chartwell our research leads us to expect the global economy to continue to recover, but with a number of aftershocks to the system thereby implying that there will be volatility. We see a rise in momentum in western economies in contrast to a slowdown in the emerging world.
In most developed economies we do not see a significant rise in the rate of inflation as the scope to raise prices is likely to be held in check by reductions in spending as governments and individuals seek to reduce the level of their debt. This is likely to limit the need for any significant rise in interest rates, certainly in the early half of the year.
In emerging economies, especially China, the rapid rise in credit growth is creating a number of asset bubbles, and so we see less relative value in a number of these markets than those which are more developed.
Credit spreads - the extra return paid on a bond over that paid on sovereign bonds - have narrowed significantly as investor appetite for risk assets has increased. If the UK were to lose its AAA-rating then gilt yields will rise and the spreads will narrow further, possibly leading to a mass exodus from corporate bonds. In such a scenario the liquidity within this sector is paramount. Although we continue to favour fixed interest as an asset class for its relative defensive qualities, the days of equity-like returns (such as those seen in 2009) have passed and we expect more modest returns in 2010.
UK commercial property is attracting increasing interest, although much of this is from overseas investors buying properties at distressed prices and capitalising on the relative weakness of sterling. If sterling recovers overseas investors will find the UK less attractive, and if gilt yields rise property will look expensive. Any rise in interest rates is also likely to hurt the sector.
A further cloud on the horizon is that 2010 might see a large number of sellers in the market, including the banks looking to reduce their exposure to real estate. This scenario assumes banks having to take ownership of properties in the event of loan defaults as debt refinancing falls due.
We believe that 2010 will be a challenging year for investors, and that barring a major political or financial crisis it should be possible to gain attractive returns in excess of cash and inflation.
James Davies - Investment Research Manager
Source: BBC Online, Reuters, Bloomberg, Newsweek, M&G