Credit and emerging markets shining light in gloomy times

Keith Speck head of Multi-Manager at Santander Asset Management UK gives his views of the markets, the macroeconomic environment and the sector opportunities available to investors.

"The volatility that characterised early 2008 has continued unabated as the wider economy starts to show contagion from the credit crunch. Lower economic growth and increased unemployment, coupled with a contraction in consumer spending has lead to deteriorating trading conditions in cyclical sectors such as retailers.

"We are seeing a marked tightening of lending criteria, leading to a reduction of 45% in mortgage lending. This in turn has depressed house prices, with year on year growth reducing by 3.8 per cent and the sentiment of RICS surveyors at record lows.

"House-builders and ancillary property services are being impacted along with mortgage banks. In 2008 there have been three major rights issues for banks, and uncertainty continues to generate daily volatility in these sectors.

"Consequently, for our in house managed equity funds, we remain underweight in retailers and banks - which will be impacted by reduced consumer spending as a result of contracted credit, and real wealth eroded by increased inflation.

"Inflation is particularly impacting the energy sector and food - which faces the increased energy costs of food transportation. We are capitalising on this through increased equity exposure to these sectors and commodities, which looks set to benefit from a rise in corporate activity.

"These atypical conditions are presenting attractive valuations by historical standards; the P/E ratio for the FTSE 100 stands at 11x and the dividend yield is 4.5%, an attractive level compared to the yield on 10 year gilts.

"Credit conditions have also improved, with increased liquidity and narrowed spreads leading to a stabilisation of markets. Spreads on investment grade credit are now 90bps, from a high of 133 bps in mid March, with high yield spreads reducing from 583bps to 488bps. This is presenting interesting opportunities in credit markets for the medium to long term. With inflationary pressures persisting, we favour short dated fixed income plays over longer-term positions.

"Elsewhere, for the in house funds, we favour positions in large-cap defensive stocks, which benefit from an increased international presence. Multi-national stocks offer exposure to above average growth emerging markets, which are better positioned to weather the global economic environment. India and China are growing at levels in excess of those offered by Western markets, though US consumer spending remains key.

"Despite the uncertainty, wage constraints should reduce inflationary pressures, heading off the threat of stagflation and creating a more positive outlook for the UK economy."