Slow recovery seen by Threadneedle’s Mark Burgess
High levels of consumer and government debt will continue to hold back economic activity writes Threadneedle’s chief investment officer Mark Burgess.
Economic indicators produced in recent months have pointed to a slightly slower pace of global economic recovery than markets had expected.
Foremost of the figures has been the Q1 GDP number for the US which was below expectations, although this was partly attributed to very poor weather. UK Q1 GDP growth was also low at 0.5%, given that the economy contracted by 0.5% in Q4.
Our forecasts for growth for the developed economies have been below consensus for some time. We anticipate slow, difficult recoveries with the burden of consumer and government debt holding back economic activity.
In light of the slow first quarter in the US, we have trimmed our GDP growth forecast for the year from 3.0% to 2.7%. Our pedestrian growth expectations for developed economies mean we expect inflationary pressure to subside and we only anticipate limited increases in official interest rates.
The above economic view leads us to retain our equity strategy of favouring companies with strong finances and able to show reasonable growth against a background that is far from easy.
Early in the year we saw significant rotation away from the strong performing stocks of 2010 into the laggards, many of which are exposed to the domestic economic cycle. Generally, this did not suit our portfolios.
However, following the initial rally, investor appetite for these stocks has weakened. In particular European banks, which saw a strong rally in the early part of the year, have come under some pressure, due to the continuing problems of peripheral Europe. We expect the eurozone to hold together and eventually muddle through but it will be a long and difficult process.
Europe is just one of the hurdles facing investors. The Middle-East crisis, the aftermath of the Japanese tsunami, inflation risks and a slowdown in the rate of the global recovery are additional problems for investors.
On the other hand, there are currently two very positive factors.
First, corporate profitability remains excellent. We are around halfway through the Q1 reporting season and companies are surprising the market with higher-than-expected earnings. Top line growth overall is better than expected and there has been less margin pressure from higher costs than had been feared.
Second, and most importantly, valuations are attractive. Price to earnings ratios are well below average and yields look good relative to other asset classes. Following a strong rally, equities may well consolidate in the short term but we believe that valuations fully reflect the uncertainties.
Elsewhere, we see limited value in government bonds. The market’s concerns about the risks of inflation, high issuance to fund budget deficits and the forthcoming ending of the second phase of quantitative easing in the US create a difficult background. We do not believe that current low yields reflect this environment.