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The investment outlook for 2010
Andrew Cole of Barings is hopeful about the prospects for markets in the year ahead.
We are positive on the investment outlook for next year at Barings, but it is likely to be a year where careful market selection and timing will be vital if you are going to be correctly positioned to benefit from rising but volatile markets. Uncertainties about monetary and fiscal policy will, we believe, be the major contributors to this increased volatility and uncertainty. That said, however, we do continue to favour equities over bonds, and developing markets over developed in this environment.
We are currently experiencing a recovery which should leave the world economy growing at a respectable pace, only slightly below the long-term growth rate. Within that, however, we expect the dispersion of growth to be much more marked next year, with an entire “alphabet soup” of recovery shapes.
In Asia and the developing countries generally, we expect to see a “V”-shaped recovery where the pace of activity picks up again relatively rapidly. In the US and Continental Europe, the shape is likely to be closer to a “U”, with slow growth until recovery begins. Japan is likely to continue with an “L”-shaped profile, where there is little sign of recovery for an extended period, while the risks of a “double-dip” seem highest in the UK.
We expect the main driver of economic recovery to be the inventory cycle next year. As companies rebuild their inventories, we expect to see a pick-up in industrial production and trade. The re-balancing of growth should trigger greater final demand from customers in Asia, with other developing economies playing an important part.
In this environment, markets have started to price in higher inflation expectations over the next three to five years. The recovery in the oil price and the stabilisation of food prices after the falls seen last year may mean that we are faced with a higher headline inflation rate sooner rather than later. How the authorities react to higher rates of inflation will be the key development for markets in 2010. As mentioned above, how central banks and governments respond, and to what extent their actions are co-ordinated, will be one of the most important things to monitor next year.
Rising interest rates, either induced by central banks or by the markets, do seem inevitable, and risk assets are likely to face a headwind as returns on risk-free assets rise. Other investment risks for the coming year include higher bond yields, hastily introduced or overly-restrictive regulations on the financial sector, and tighter fiscal policy as governments try to balance their books.
All of these issues have significant implications for the behaviour of currencies. It is our belief that the US authorities will not step in to prevent the US dollar from continuing its long-term decline. We are mindful that a sooner than expected rise in interest-rates from the Federal Reserve could be the first signal that there has been a policy change in Washington, but for now we are inclined to believe that we have probably seen the majority of the US dollar’s weakness against developed market peers. Pressure is, however, likely to increase on those currencies in the developing sphere, some of which have a pegged or semi-pegged regime.
Our overall stance is to continue to favour equities over bonds. We believe that government bonds are expensive, and do not offer a sufficient risk premium to protect investors over the long term from inflationary risks. Cash, while safe, offers a negative real rate of return, after inflation. Equities, on the other hand, while no longer quite as attractively valued as they were at the start of 2009, offer reasonable value if we assume even a mediocre rate of economic growth around the world.
Within equities, we continue to favour the reasonably priced growth on offer in Asia and the developing markets. Taiwan is one of the markets we are most positive on in Asia at the moment. As the relationship with mainland China has thawed and transport links are re-established, we expect to see a healthy inflow of capital back into the Taiwanese equity market. From an asset allocation perspective, we also believe that the UK equity market is attractively valued for equity investors at the moment, despite any misgivings we may have about the outlook for the domestic economy.
Our least favoured equity market is Japan. All the evidence we are seeing suggests that Japanese manufacturing and services continue to be hollowed out by rivals elsewhere in the region, which are able to compete aggressively on price as well as quality. Within the region we are also cautious on the prospects for Malaysia. Although the pace of economic growth in Malaysia is ahead of 10% on an annualised basis, the evidence suggests that businesses continue to struggle in this environment. With the private sector increasingly sidelined, we believe that more attractive investment opportunities can be found elsewhere.
Our favoured investment theme for next year remains a long-term play on real assets, which offer a degree of protection against the risk of rising inflation in the future. We continue to believe in the supercycle for commodity prices. In the developed world, the US dollar, the Yen, the Euro and Sterling all have issues. This underpins our bullish stance towards gold, and we are very positive on the materials sector across many of the portfolio we manage.
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