Aberdeen sees a tougher year ahead

Aberdeen Asset Management believes that 2010 will be a challenging year for investors as the economic recovery remains fragile.

While there are signs of economic improvement with news of the Euro-zone, Japan and the US emerging from recession, markets may have reacted over-zealously with the equity and fixed income arenas now discounting decent growth with low inflation.

We may not revisit the distressed levels seen during the turn of 2008/2009, but investors need to be mindful of issues that remain.

Although the US housing market, one of the catalysts for financial crisis, is recovering slowly; unemployment is rising and savings rates remain too low. Furthermore, western governments, particularly the US and the UK, need credible plans to balance their budgets in the medium term.

For government bond investors, the state of public finances is a growing concern. However this negative backdrop should be tempered by exceptionally favourable monetary policy which will likely remain unchanged until at least the last quarter of 2010. Indeed gilts, Euro government bonds and US treasuries ought to outperform cash again next year. Despite rebounding strongly over the past few months, credit and high yield markets still look attractive, as investors search once more for yield. In investment grade credit, spreads remain significantly wider than during the dot-com bubble and subsequent crises at the beginning of the decade. Similarly, European high yield risk premia remain high. However, while economic uncertainty persists good security selection will be increasingly important. Emerging country debt market fundamentals remain appealing, and in a similar vein accommodative global monetary policy, low inflation risk and rising growth expectations should be supportive for the asset class, particularly local currency issues.

Within FX, the US dollar looks set to remain weak as plentiful supply sustains its role as a funding currency, but bouts of risk aversion could promote better performance periodically. Commodity linked currencies hold little value and in contrast could suffer from risk averse periods. Meanwhile in equity markets, valuations are no longer as compelling as they were 12 months ago. Corporate profits have rebounded somewhat with the aid of severe cost cutting and margin improvement. Revenue growth now has to kick in to meet expectations for future earnings which is dependent upon better global growth which still has significant hurdles to overcome. However we do acknowledge that low short term interest rates when compared with higher dividend yields mean equities do remain attractive: liquidity abundance may again sustain positive performance in the
coming year.

In terms of real estate markets, we anticipate stability in capital values, particularly in the UK. Indeed UK market yields look cheap in the long-term, as yield spreads have not compressed versus other asset classes. We do not anticipate any immediate turnaround in rental growth, but markets should follow the usual pattern of a recovery in capital values leading rental growth by some margin.

Mike Turner, Head of Global Strategy & Asset Allocation, commented: "As 2009 draws to a close, it seems reasonable given the strength of this year's market rallies, and continued uncertainty surrounding the economic environment to be somewhat more cautious in our outlook for 2010. A degree of diversification into real estate markets seems therefore to be an attractive proposition, especially in the UK.

"For our multi-asset portfolios, equity asset allocation continues to favour Asian and emerging market companies, given these regions' strong foundations. In fixed income markets, we still see potential in credit and emerging market debt, where current prices remain attractive.

Thanks to our strong disciplines and meticulous stock selection process, we believe we remain well placed to identify undervalued securities that will outperform in the long term."