UK: Investment Management Outlook, January 2011

Last Updated: 25 January 2011
Article by Smith & Williamson

World

Factoring in tail risks

From a macro risk profiling perspective there are three key concerns over the outlook for 2011.

The first is the consequence of a sustained rise in bond yields. The surprise announcement of additional US fiscal stimulus in December 2010 was the catalyst behind a significant rise in both US and global bond yields. The rationale for this reversal mainly resides with a recalibration to higher 2011 growth expectations, but there is concern that the expanded fiscal deficit will become progressively harder to finance, implying sequentially higher yields. Rising bond yields would exert downward pressure on equity valuations and strain budget deficits. However, given that the Federal Reserve remain committed to their QE2 programme and will not want to see long term rates move much higher we expect bond yields to remain range bound for the foreseeable future.

The second risk is that Chinese monetary policy tightening overshoots and slows the economy more than expected. While the authorities have been too slow to curb rising inflation and consequently interest rates will increase in 2011, the ultimate objective is to curtail speculative credit growth and not change the 8-9% growth trajectory of the economy for 2011.

The third risk emanates from Europe. Solvency concerns surrounding peripheral Europe persist with the focus progressively moving to Spain. In 2011 markets are likely to force Germany to choose between providing support to a coherent bail out package or face the consequences of a disorderly fragmentation of the euro-zone. Logic dictates they will eventually opt for the former.

At a micro level corporate balance sheets and free cash flow are in good shape and c 4% global GDP growth in 2011 provides scope for subsequent earnings upgrades. Indeed in the UK we are already seeing positive earnings revisions. With most regional market PE's still below their respective 5 year averages the scope for the combination of earnings growth and valuation expansion provides a constructive long term back drop for equities. However, as in 2010 the profile of returns will likely remain volatile.

US

The announcement that congress and the administration had reached agreement on the extension of the Bush tax cuts and unemployment benefits and introduced a surprise 2% cut to payroll taxes resulted in a savage sell off in the bond market with yields on the 10 Yr bond rising from 2.9% to 3.4% in short order. The bond yield reversal reflects a combination of the ratcheting upwards of growth expectations in response to the potential boost to disposable income from the payroll tax cut, and also concerns that the additional fiscal stimulus will sustain a budget deficit in excess of 10% of GDP for the next two years. The ratings agency Moody's has already voiced concern over the lack of fiscal constraint. This criticism could become a recurring theme in 2011. However, the fact that break even inflation rates have remained relatively static while real yields have moved higher would indicate that inflation linked bonds perceive this to have more of a growth than inflationary impact. Given that the Federal Reserve are likely to persist with the bond purchase programme we expect bond yields to remain range bound until they eventually start factoring in interest rate tightening.

The key equity market drivers: liquidity, growth expectations and earnings revisions remain supportive. Valuations also look modest but could be constrained by rising bond yields. Although bullish sentiment indicators have become quite extended the backdrop to equities remains favorable.

UK

Collateral damage to the MPC's credibility

The frustration that that UK inflation data refuses to come under control is palpable and is inflicting damage to the Bank of England's credibility. A succession of exogenous factors such as the oil price, food costs and VAT hikes have contributed to both the CPI and RPI moving well above expectations. While the MPC continue to believe that the UK is facing several disinflationary headwinds (fiscal consolidation, weak credit growth, negative real incomes and a fragile housing market) there is a risk that markets are tiring at their loss of inflation fighting credentials. While they have bought time with the projection that CPI will peak at 3.5% in early 2011, any push back in the timing of the subsequent decline in the 'May Inflation Report' or a surge in inflation expectations could well see the MPC succumb to pressure and begin the process of normalizing interest rates. The first quarter of 2011 will clearly be a very important period in the determination of UK monetary policy.

With two thirds of revenues coming from overseas, the equity market remains more dependant on global growth than the UK economy. Emerging market exposure alone amounts to 20%. Corporations have been delivering strong free cash flow and have strengthened their balance sheets over the past year and enter 2011 in good shape. Encouragingly, after a lull, analysts have started to revise their 2011 EPS estimates higher. A combination of 5% EPS growth and a shift in the current prospective PE of 10.5x to the 5 year average PE of 11.2x indicates 10% upside for the market. With a 3.5% dividend yield the UK market has the scope to deliver reasonable total returns in 2011. The caveat is that as in 2010 the profile of the returns is likely to remain volatile as macro uncertainties (Euro-Zone concerns, UK inflation, Chinese interest rates etc) impact sentiment.

Europe

Euro-zone approaches a tipping point

While the purchase of Portuguese and Irish bonds by the ECB in early December did produce a brief lull in the rise in peripheral bond yields, the announcement that the rating agency Moody's was threatening to reduce Spain's Aa1 rating due to debt funding risks has once again highlighted the structural problems within the Euro-zone. Political schisms, particularly regarding the German reluctance to be seen to be more supportive, have engendered a sense of leadership vacuum.

Spanish bond yields are getting perilously close to the 6-6.5% level that triggers solvency concerns (the inability to shrink the debt to GDP ratio). If this were to arise, the pressure on Germany to agree to an increase in either QE, the EFSF support facility and/or the introduction of a eurozone bond would intensify. Although these are all essentially liquidity measures and don't address the core solvency problem they will be needed to stop a melt-down scenario unfolding. The euro-zone is evidently fragmenting; the key issue for markets is whether this can be managed in an orderly manner over a long enough time frame. It is in Germany's ultimate interest to avoid chaos. The euro has fallen 7% against the US dollar since early November. It looks vulnerable to more weakness in 2011.

Asia

China

The 5.1% November CPI report was significantly higher than expected. Most of the rise was attributable to a 12% increase in food price inflation and core inflation is only a modest 1.9%. Nevertheless, despite increasing the reserve ratio 6 times and increasing the lending rate by 50bp, the authorities are perceived as being behind the curve in terms of adjusting monetary policy fast enough to battle inflation. Consequently, more tightening is expected in 2011. While there is clearly a risk that the tightening jeopardizes growth, the fact that M2 growth is currently 19.5% and not the 30 % seen in 2007 increases the chances that they can still deliver between 8-9% GDP growth.

Japan

The Japanese market continues to be positively correlated to the US bond yield. The logic runs that when the latter rises, signifying an up tick in growth expectations, the Japanese market, which is dominated by exporters tends to do well. Consequently the recent rise in US bond yields has translated into 12% rally in the Topix index. The modest decline in the yen has also helped but the trade data has shown that Japan exports volumes have not so far suffered from the significant appreciation in the yen. Longer term Japan remains hampered by its poor demographic and trend growth profile.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.