Threadneedle’s Burgess sees reasons for caution, but also reasons for hope
Mark Burgess, chief investment officer at Threadneedle, says there are signs of hope for investors from the US and China amid the need for a continued cautious approach.
We have held a very cautious view of the global economic environment for some time, and events have proved this caution to be well founded. We continue to expect that the economic outlook will be difficult and that the overhang of debt will cast a very heavy shadow for an extended period. However, we believe there may be a few grounds for expecting some improvement in the near future. In the US, there have been a number of economic surprises on the upside and the housing market appears to be showing a useful recovery, even before any beneficial impact from the Federal Reserve’s recently announced QE3 policy, which is aimed at lowering mortgage costs. While the earlier uncertainty over the outcome of the US presidential election has now been resolved, and President Obama is back in the White House, the fiscal cliff continues to cause concern and has led to the postponement of investment decisions. We expect more details of measures to tackle the fiscal cliff shortly, and this may release some pent-up demand in the more predictable environment that should follow.
Meanwhile, the news from China shows signs of the economic slowdown having bottomed. The latest purchasing manager’s index of manufacturing activity was above 50, indicating expansion, and the recent destocking phase appears to be largely over. In addition, the leadership transition is underway and this could lead to some stimulatory activity by the new administration.
We also have generally lower than consensus forecasts for corporate earnings growth. Whilst the current reporting period has been a fairly mixed one, with a higher percentage of disappointments than we have seen for some time, the pace of downgrades to forecasts appears to have slowed.
Another of our long-held views has been a strategic underweighting of bank shares. This month we undertook extensive in-depth analysis of the sector and concluded that the ‘tail risk’ scenario of wide-scale failures had largely passed and that the sector would perform more in response to regional conditions rather than as a global group. The situation in the US is increasingly positive, with relatively robust balance sheets and a recovering housing market. The outlook for the UK and Europe is less encouraging with further balance sheet adjustments required and a sluggish economic background. Emerging economy banks appear fairly well placed in light of economic expansion and lowly-leveraged consumers. On balance, we are more constructive on the sector, but there are still significant issues and the local situation and stock specific factors will be increasingly important for performance.
Elsewhere, we expect the search for income to continue, which will be beneficial for higher yielding bond classes and for companies with high, well-funded dividends. The yield on equities, combined with the likely impact of quantitative easing around the globe, should act as a support for shares. However, opposing this are the risks from the eurozone, the fiscal cliff and the difficult economic background, which leads us to adopt a neutral position on equities. We are cautious on UK commercial property despite a reasonably attractive yield; demand is weak and a huge refinancing operation needs to be undertaken. We expect commodity markets to be pulled in different directions, with quantitative easing most likely to benefit precious metals.
We see tight supply conditions in the oil market, and a shock to production cannot be ruled out given Middle East tensions. However, buoyant agricultural markets will lead to heavy planting, which may limit future gains. Furthermore, the sluggish global economy and the shift in China from investment-led growth towards greater emphasis on consumption are negative for industrial metals. We have a neutral view on commodities overall.