Managing assets in 2009
March 2009
If the global economy is likened to a
hospital patient, it has just left the emergency room and is now in
intensive care. Medicine is being administered in the form of a
range of monetary and fiscal stimuli and the key policymakers, much
like a doctor caring for a patient, must wait and see if they work.
Politicians, central bankers and investors alike will be monitoring
the situation closely for signs of a recovery. Collapsing profits,
rising defaults and corporate failures are inevitable in the months
ahead and we suspect there will be far more bad news than good news
in 2009, particularly during the first half of the year.
Despite our bearish view of the world, we
remain alive to capturing investment returns where we believe
current market inefficiencies present opportunities. Sound
investment decisions typically rely on an investor being able to
clearly assess the prevailing macro-economic environment and apply
this to calculate the value of future cash flows from an investment
or asset class. In our opinion, the lack of visibility in terms of
future earnings from the corporate sector makes committing all but
very modest levels of capital to equities far too risky. We believe
it is highly probable interest rates will continue to fall and
remain low, and that inflationary pressures have abated for the
near term. However, with cash rates so low, equities could be a
better long-term bet than cash, even now. We believe equities will
become even cheaper during 2009, perhaps even 20% - 25% below
current levels, and in our view the ‘bottom’ may well occur before
the year end.
High quality corporate bonds are currently
very appealing and very much back in vogue. Low interest rates
result in coupons being more attractive and causes the value of a
bond to rise. Falling inflation, or possibly deflation, improves
the real return of the same bond, again increasing its attraction
and value. The investment grade corporate bond sector is currently
pricing levels of corporate defaults consistent with the economic
depression of the 1930s. Whilst we believe default rates will rise
sharply over the coming months, we suspect, given the scale of
monetary and fiscal stimulation applied to the economy (which
certainly never materialised during the Great Depression), current
market projections will prove over-stated and bond prices will rise
as worst-case scenario expectations recede.
The opinions in this article are those held
by the authors at the time of publication.