Worldwide: Investment Management Outlook - April 2012

Last Updated: 13 April 2012
Article by Smith & Williamson


US continues to lead the way

Investor sentiment continues to improve and appetite for risk assets has held up well with many major equity markets now fully recovered from the losses made last year. Global equity markets continue to be supported by central bank liquidity and growing optimism that the recovery in the US economy is gaining traction.

In Europe, Angela Merkel, the German Chancellor, appears close to backing plans to increase the size of the eurozone's 'firewall' in an attempt to stem the contagion from the Greek debt crisis. For the time being the markets appear to be giving the latest rescue plan for the euro the benefit of the doubt, despite mounting evidence that large parts of Europe are falling into recession.

Oil prices have meanwhile reached uncomfortably high levels which if sustained will raise input costs and cut disposable incomes, threatening to derail any domestic demand-driven recovery the world over.

Economic growth, especially in the UK and Europe, remains extremely sluggish and the reliance on the US to lead the way is likely to continue through to the end of the year. In this lower nominal growth environment, we continue to believe the best long-term equity strategy focuses on companies with robust business models, global franchises and greater exposure to high growth markets.


Growth remains sluggish

As expected there were very few surprises in the Chancellor's March Budget, but Mr Osborne attempted to hang an 'open for business' sign outside Britain's shop door. While tax cuts and changes to spending were fiscally neutral, a fall in the rate of corporation tax to 24% from next month (and to 22% by 2014) aims to reduce barriers to entry and improve the UK's global competiveness. Nevertheless, the Coalition Government's plans assume UK growth will return to levels seen before the 2008 financial crisis within three years. The UK has been one of the world's worst performing economies since mid-2010 and while we have seen modest improvements to the Manufacturing and Services Purchasing Managers' Indices

(PMIs) in recent months, the poor external environment, continuing government consolidation and lack of confidence in the private sector are likely to lead to further sluggish growth in the near term. Unemployment remains at a 17-year high. The UK's exposure to Europe, its main trading partner, will continue be a drag on the economy and it remains vulnerable to the risks a recession in the region will bring.


US economy continues to gain traction

The US continues on the road to recovery and looks to have resumed a moderate and sustained GDP growth trajectory. Employment growth remains robust and may have turned a corner. Non- farm payrolls increased by 227,000 in February, while upward revisions added another 61,000 to the gains made in the previous two months. Recent non-farm payroll figures would suggest that the growth and improvements to the labour market are consistent with a better rate of economic growth than analysts are forecasting. Although the headline rate of unemployment remains unchanged at 8.3%, if ADP payroll surveys and non-farm payrolls continue on their current trend we could see the unemployment level fall significantly and a surprise on the upside to GDP growth.

For now at least the US economy continues to lead the way among the world's developed markets and provides a guiding light through an uncertain economic climate in the UK and Europe. In a recent speech, Ben Bernanke underscored the Federal Reserve's continued support for loose monetary policy, as many investors had begun to doubt the central banks pledge to keep interest rates exceptionally low until late 2014. Although there has as yet been no indication of another round of quantitative easing, low interest rates for the foreseeable future will continue to be supportive for equity markets. Cash on corporate balance sheets has now risen to record levels, with the economic seas in America now looking far less choppy; we could see US companies put that cash to good use and US Inc move to the forefront once more.


Divergence between stock market performance and economic growth

Eurozone GDP and PMI figures released during the month continue to reveal the stark contrast between equity market performance and economic growth in the region. While equities continue to ride the wave of liquidity provided by the European Central Bank (ECB), leading indicators and PMIs all point to a contraction in the first quarter of 2012.

With sentiment towards global economic growth continuing to improve, Europe is no longer dominating media headlines, for now at least. The ECB's three-year lending operation (now totalling over €1trn) has injected much needed liquidity into the European banking system and has stemmed the threat of an immediate eurozone meltdown. In spite of a reduction in government bond yields in many peripheral nations, risks clearly remain and the policy response has been one of buying time rather than addressing the core issues. A growing concern is Spain, Europe's fourth largest economy. Despite the Government announcing new fiscal austerity measures, the ten-year government bond yield has risen to 5.5% for the first time since early January and is now above yields in Italy. With the economy in a technical recession and unemployment among the highest in Europe at 22.9%, the fear is that Spain's poor economic growth prospect could leave the country needing a bailout.


Chinese economy needs to find the right balance

Now the seasonal effects that distorted Chinese data at the start of the year have had chance to clear, we can take a step back and consider China's growth prospects for the year and what the market expects it to achieve. Given the slowdown and sluggish demand from many parts of the developed world, mainly Europe, the cooling down of China's export-driven economy has been somewhat inevitable. A growth rate of 7.5-8% is still very much achievable if trade with the US continues to be strong and if domestically policymakers can pull at the right strings. We are beginning to see signs that China's transition away from export-driven policies is gaining traction as the Government seeks to give the economy better balance. In February China posted its largest trade deficit in over a decade ($31.5bn) as imports grew 39.6% year-on-year (YoY), compared to an 18.4% rise in exports. Retail sales have risen steadily over the past year with many large multinationals, including Apple, finding strong consumer growth in the region. With inflation easing to 3.2% in February, it's slowest pace in almost two years, policymakers have scope for further monetary easing and are expected to shift their attention to supporting domestic growth.

Japan – falling Yen continues to ease pressure on the economy

Japanese equities have continued their strong start to the year with the Nikkei 225 erasing the losses caused by last year's tsunami as investors continue to warm to the region. Companies have clearly been benefitting from the Ą20trn ($240bn) earmarked by the Government for reconstruction since the earthquake devastated output last year. The economy continues to show signs of recovery, aided by the Yen falling from its post-World War 2 high against the dollar in October and central bank intervention. Since the middle of February when the Bank of Japan announced it would expand its asset purchase programme and target an inflation level of 1%, the Yen has depreciated

more than 9% against both the dollar and Korean Won, helping the competitiveness of Japan's large exporters. Indeed, exports rebounded from -9.3% YoY in January, to -2.7% YoY in February, with the economy posting an unexpected trade surplus for the month. Most of this appears to have come as a result of improving consumer confidence in the US, with exports surging to 14.8% YoY in February.

Domestically, we have seen improvements in consumer confidence and household spending as a result of pent-up demand and a rebound in the Japanese economy. However, importing expensive fossil fuels (the result of nuclear power capacity still at low levels) continues to impact input costs. Japan's growth prospect remains reliant on its export sector and on a related note, the strength of its currency.

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.

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