Quarterly review affirms cautious outlook, says Threadneedle’s Burgess

Mark Burgess, chief investment officer of Threadneedle, comments that factors around thew world still point to a cautious approach being the best one to have.

Threadneedle’s quarterly Economic Review meeting in September reaffirmed our cautious outlook for global economic growth. The US economy has been outperforming other developed regions but is now showing signs of heightened concern ahead of the automatic fiscal austerity package (the fiscal cliff) amounting to 4% of GDP. This comes into force at the end of the year unless politicians can agree on an alternative package. A watered down solution is expected but no-one knows who might be hit by these new proposals; hence uncertainty and deferred decision-making by consumers and businesses. We expect US growth of 1.5% in 2013 assuming a reasonable fiscal agreement, but probably a more contractionary one than the fairly complacent consensus expectations. Failure to reach agreement on the fiscal cliff would lead to a US recession and have severe consequences for global growth. On a more positive note, we see a recovering housing market, helped further by the Federal Reserve’s announcement of quantitative easing, aimed at bringing down mortgage rates.

The ECB’s recent commitment to support peripheral sovereign bond markets, in certain circumstances, has reduced the risks of a eurozone break-up. Despite this, the growth outlook remains bleak as additional austerity measures have been announced, loan growth has slowed further and weakening global growth is hitting the exports sector. We now expect -0.5% GDP growth in both 2012 and 2013. In the UK, we also forecast -0.5% growth this year, depressed by public and private sector deleveraging. However, we expect a slightly better performance in the coming quarters than in the immediate past. Real income growth has moved into positive territory and a number of indicators, particularly employment data, suggest that the official figures may be understating activity.

China has seen growth well below traditional levels due to weak construction activity, reduced competitiveness and destocking. The transition to a new administration later this year and residual inflation fears are delaying a policy response. Consequently, we have cut our GDP growth forecast to 7.6% for this year and next.

Announcements on bond purchases by the ECB and Federal Reserve have led to strength in risk assets and initially the rally in equities was led by the more depressed sectors and stocks. We made some tactical moves to benefit from this, but do not expect a sustained period of performance from the more challenged companies. Our economic views point to a prolonged, tough environment and therefore strategically we have a preference for strong businesses, able to show some growth and well suited to today’s difficult world.

The slow growth backdrop (which is leading to downgrades to corporate earnings forecasts), the continued eurozone risks, the approaching fiscal cliff in the US and geopolitical tensions in a number of places, led us to adopt a small tactical underweight in equities in the summer. Whilst these concerns remain, we believe the ECB’s potential bond purchase proposal has removed a significant part of the risk of a eurozone break-up and the Federal Reserve’s latest quantitative easing programme is likely to lend support to risk assets. These actions and the attractive valuations for equities have encouraged us to move up to a neutral position in this asset class. In fixed income, we continue to have a strategy that favours higher risk bonds over government securities.

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