Looking ahead in the investment markets
In assessing what lies ahead in 2011, it makes sense to consider
those issues which we have some clarity over and, thereafter, seek
to identify what surprises we may have to plan for. The message
from the Fed is currently very clear in that Ben Bernanke and the
Federal Open Market Committee (FOMC) will maintain their loose
monetary policy until they are sure the US economy is on a
sustainable path of recovery, deflationary pressures have abated
and unemployment rates have started to come down. This is positive
for US equities. It is also clear the corporate sector is generally
in rude health with growing profits, excess cash on balance sheets
and a rising appetite to recruit new workers - particularly in the
US small firm community. This, too, is positive for equities.
Finally, investors have clarity that the developing world has
decoupled from the developed world, with strong growth sustained by
the former, despite sub-trend growth in the latter. This decoupling
extends to a divergence in monetary policy with Western central
banks explicitly seeking to inflate assets while emerging markets
are actively trying to limit asset price appreciation through
capital controls, as mentioned earlier. This policy stance suggests
it would be sensible to be committing risk capital to developed
market equities and emerging market bonds.
What about surprises? We have already referred to geopolitical
risks, the issues facing China and European funding problems,
albeit an escalation in any of these should not come as a surprise
to investors. We believe markets remain overly accepting of the
fiscal deficit being run by the US government, something Ben
Bernanke has recognised commentators consider unsustainable. In a
recent address to the US Congress, the Chairman of the FOMC issued
a warning stating - 'the longer we (as a nation) wait to act, the
greater the risks and the more wrenching the inevitable changes to
the budget will be.' The political climate in the US is tense and
budgetary issues will be hotly debated. We believe it will be
important for investors to keep a close eye on developments as they
unfold. This is likely to be a story for beyond 2011, but one
which, as we have witnessed in Europe, cannot be ignored
indefinitely. Staying in the US, the housing market remains a focus
of ours; a stable and rising market is important in that it boosts
consumer confidence, bank balance sheets and global equities. Data
recently released is conflicting in that the Case Shiller price
survey for October was weaker than expected, yet pending home sales
were better than expected. What is clear is house prices in
significant metropolises such as Las Vegas, Miami, Detroit and
Chicago have started to decline again having initially stabilised.
US banks are much better capitalised than they were ahead of the
crisis, but they would, once again, feel the pain of an additional
wave of defaulting loans on their balance sheets.
There are two additional potential surprises we need to be
thinking through and these centre on the important issues of
interest rates and inflation. The consensus view on both issues is
interest rates in the major Western economies will stay low for a
prolonged period and excess capacity coupled with elevated
unemployment means inflationary pressures will be weak. An
unexpectedly strong recovery would be a catalyst for faster
increases in official interest rates, which would lead to
heightened equity market volatility, a sell-off in long-dated bonds
and a strengthening dollar. The latter is normally associated with
emerging market underperformance. Disinflation, and the fear of
deflation, was the prompt for the Fed to introduce QE2, however,
lagged food and energy costs are tailwinds to inflation, as are
indirect taxes in the case of the UK. Printing money and debasement
of the dollar means, for many, soaring inflation down the road and
this will have a dramatic impact on asset prices. We need to be
watchful.
To conclude, some of the fog has cleared as we look ahead,
however, we remain in uncharted waters given the events of the last
two years and the massive public policy response implemented to
manage the fallout. The prices of risk assets have risen sharply
over a short period of time and this momentum may stall, or
reverse, on disappointing economic or corporate newsflow. Markets
are becalmed with the fear gauge, being the VIX index, settling at
levels that have historically signalled the calm before a storm.
Asset class diversification, sound stewardship and a cautious
approach has served us well and these will remain our watchwords
for 2011 as we build and manage portfolios on behalf of our
clients.
All data herein is sourced from local exchanges via Reuters,
Bloomberg and other vendors. The information herein has been
obtained from public sources believed to be reliable. Fairbairn
Private Bank makes no representation as to the accuracy or
completeness of such information.