Barclays Wealth March signpost investment strategy report

United States: We believe the US is flirting with recession, but set to do a lot better during the second half of the year than during the first half. We expect full-year growth of just 1.3% – i.e, well below general expectations. That is consistent with zero growth in Q1 and Q2 and “decent” (near-2½% growth) in Q3 and Q4.

Inflation is turning out higher than expected at the start of this year. It is now five years in a row – with 2008 set to be the sixth – during which inflation has turned out higher than the consensus expected, and at the same time that growth turned out lower than expected. That combination is increasing the chances that the Fed ends up constrained in how much easing it can carry out, at least without other incurring significant costs (such as forcing the dollar lower).

The Fed looks set to cut rates to 2% or so, taking risks with inflation. That policy is not one that policymakers here or in Frankfurt would adopt themselves, faced with the same predicament as the Fed.

United Kingdom:

The economy is now clearly slowing, albeit less abruptly than the US. The consensus is overly sanguine. Most likely growth will disappoint general expectations this year and next. We expect growth this year of 1.6% and 1.8% in 2009. If we are right, then that would be the worst two-year performance since the recession of the early 1990s.

The housing market is now cooling, with house prices falling. We expect that process to be more painful than general expectations.

As across much of the globe, inflation has surprised on the high side of late – thanks mainly to higher food and energy prices. In the case of the Bank of England’s MPC committee, this is leading to a vigorous debate concerning how much and how fast they should ease. We look for 100bp of cuts by year-end.

Rest of the world:

Our latest gauges of “cohesion” – i.e., an attempt to see how closely different regions’/countries’ business cycles move together – give us greater conviction in our view that neither Europe nor Asia can “plough their own furrow”. A useful rule of thumb is that for every one percentage point (pp) lowering of US growth forecasts, it is necessary to lower one’s euro-area and Japanese GDP forecasts by about ½ pp. Consequently, we are a little more gloomy than most regarding prospects for these economies this year.

The ECB is likely to start trimming rates around mid-year, despite its worries about high (3%+) inflation and still-strong credit and money growth.

MARKETS

Asset allocation:

In terms of long-term (strategic) plays, we continue to see an opportunity in being long equities versus bonds. In terms of short-term (tactical) plays, however, we recognise that the poor macro back-drop may well make it tough for this move to take place. Consequently, we are sitting on the sidelines, looking for an opportunity to put that position on.

With tax rebates set to boost US households’ incomes towards the end of the second quarter – and data emerge regarding whether or not households spend/save this money during the third quarter, we suspect that the markets might only stage a significant rally around this time.

If this happens, the key question for analysts/investors and indeed policymakers will be the longevity of any pick-up. Increasingly, we are growing concerned that the pickup, assuming one comes, might not have much in the way of legs to it.

Equities:

We have retained our year-end forecasts for the main markets, despite slight declines in most markets having occurred during February. Despite a poor end to the month, February nevertheless felt as if a base might be forming – with markets proving to be less fragile, and better able to bear bad news than late last year or early this.

“Fragile” nevertheless remains an apt way to describe market participants still. There are thus more downside risks to upside ones, especially short term.

Our valuation frameworks continue to point to upside potential in most “risky” asset classes, including most developed equity markets. Our main equity sector calls remain in tact too.

Fixed Income:

The short ends of most of the major futures/swaps markets seem to us to be pointing in the right direction – i.e., to more rate cuts. But we suspect reality will turn out to be one in which policymakers act a little more aggressively than generally expected.

Bond yields are too low, relative to fundamentals, reflecting their safe haven status. That will change, in time, but probably not quickly.

Likewise, the sell-off in credit looks overdone, given the likely level of defaults etc… But, it would take a brave investor to position for spread narrowing at this juncture. We suspect that that, like most of our longer term strategies, might well be a story for the second half of this year, rather than the first.

Currencies:

Our favourite trade for 2008 – sterling weakness – is turning out well thus far. Indeed, it has moved so far, so fast, that it we felt we needed to revisit our analysis, by trying to gauge the so-called Fundamental Equilibrium Exchange Rate (FEER) for the pound. The conclusion? We fear that FEER says the same thing: sterling is vulnerable, especially now that the BoE is cutting rates.

We continue to look for the Swiss franc and Japanese yen to appreciate in trade-weighted terms this year, in part thanks to carry-trade unwinds and in part because they look cheap relative to our long-term trend (“kernel”) analysis.

Even the euro looks expensive and the dollar cheap according to our long-run fair value gauges, we expect the dollar to continue to depreciate, and the euro rise.