Threadneedle August investment strategy

Sarah Arkle, Threadneedle Chief Investment Officer comments: Sentiment towards government bonds has benefited from the fall in the oil price, which has helped to ease inflation fears, and investors' reduced risk appetite. If sustained, a reduction in inflationary pressures should allow central banks to lower interest rates to stimulate economic activity. In the credit markets, the failure of a number of US regional banks and the re-emergence of the fallen angel theme have characterised a grim month. While valuations for investment grade bonds are compelling, the fundamentals continue to deteriorate. For high yield, the fundamentals are also poor, especially for cyclicals, and there have been ratings downgrades. However, valuations have become more appealing with the widening of spreads. Emerging market bonds have benefited from falling inflation risks.

Equities

The UK economic outlook remains challenging given the uncertainties over the oil price, inflation, the housing market and government finances. The market is likely to remain volatile driven by short-term news flow, and will be characterised by continued rotation. Earnings forecasts continue to fall, with the easing of the oil price a major factor -37% of UK earnings are directly related to resources.

The past month has seen some sharp rotation within European markets. Profit warnings have come through in a range of sectors and there has also been some weakness in areas previously benefiting from emerging market growth. We prefer the better capitalised companies, industry leaders and businesses with pricing power.

The main difference between Japan and other leading G7 economies is that the Japanese private sector does not need to deleverage. Households are cash rich. However, Japanese exporters are feeling the impact of slowing world economies.

Asian markets continue to be buffeted by global economic concerns. The direction of oil and food prices remains key and both have fallen from their peaks. Once inflation is deemed to be under control, investors will become less concerned over monetary tightening and the knock-on effect on economic growth and corporate profits.

We have revised down our 2008 forecast for US earnings growth from 3% to zero, which is below consensus. The energy sector provides a significant cushion for overall earnings. The cautious behaviour of the corporate sector during the recent period of economic expansion should mean that the current downturn is not exacerbated by significant inventory reductions or cuts in the labour force.

Within Latin America, the Mexican economy is slowing as a direct result of the slowdown in US growth. Recent inflation data in Brazil has proved better than expected and retail sales remain very strong. Both the Brazilian and Mexican central banks raised interest rates again to try and anchor inflation expectations.

Property

We remain underweight in UK property. The UK economic downturn looks more severe than originally anticipated, with spiking inflation and rising unemployment. As a consequence, the second half of 2008 could see further downward pressure on property valuations, fuelled by slowing occupational markets. A recovery in the UK property market remains contingent on liquidity returning to the bank lending markets. However, overseas investors and longterm institutional investors are waiting for a suitable opportunity to increase their real estate weightings.