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SWIP 2010 market predictions

29th December 2009 Print

In the second half of 2009, equities and corporate bonds made some prolific gains as investors bet on a return to economic growth. Everyone hopes 2010 will bring confirmation of this recovery.

SWIP's fund managers look at whether investors' optimism will be proved justified, and analyse which areas can be expected to perform in the current economic environment.

Kim Catechis, head of emerging markets at SWIP, on global emerging markets:

"As the credit crunch began to exert its influence late in 2008, emerging market equities suffered a dramatic fall, with global investors beating a hasty exit from riskier asset classes. But ever since the first quarter of 2009, emerging economies have bounced back with surprising strength. And the prospects for 2010 appear solid.

"Much of the credit for this goes to China. The big emerging markets story of 2009 was undoubtedly its aggressive $582 billion economic stimulus package, aimed at infrastructure, housing and the consumer. And as economic recovery strengthens during 2010, China will continue to lead the way: double-digit GDP growth is forecast next year. Indeed, we anticipate that growth in the BRIC economies as a whole (Brazil, Russia, India and China), will far outstrip that of the advanced economies.

"Looking ahead, stronger growth, continued low inflation in most economies, and low real interest rates are all factors that favour emerging markets. But one of the keys to future growth is the emerging market consumer. Unlike their counterparts in the developed world, consumers in emerging markets are at the beginning - rather than the end - of the credit cycle. For example, mortgage debt in the BRIC countries accounts for only 9% of gross domestic product, compared to 73% in the US. Investment opportunities resulting from this include banks, housebuilding and consumer stocks.

"While SWIP remains alert to the various trends that affect the emerging market universe, our investment focus is still on identifying companies with strong business models and robust balance sheets managed by teams capable of navigating through a difficult global backdrop."

Peter Cockburn, head of UK equities at SWIP, on UK equities:

"The speed and magnitude of the rally in equity markets over the past eight months has been the subject of fierce debate among market participants and observers. The bears argue that the gains have been fabricated by government intervention, which will provide only temporary economic respite. The bulls counter that the unprecedented actions taken by central governments to stabilise the financial system and kick-start economic growth are still not fully reflected in equity valuations.

"The bulls are clearly in the ascendancy. Stock markets have continued to grind higher, driven largely by the expectation that corporate profits have troughed. This appears to be a valid assumption as we continue to see more earnings forecasts revised upwards than down. Compared to other asset classes such as cash and government bonds, equities continue to offer compelling value. And while the UK economy may still be struggling, the direction of UK-listed share prices is influenced more by global economic growth than domestic growth (the FTSE 100 generates close to 70% of its combined profits from overseas). Equity valuations remain very attractive both in absolute terms and relative to other asset classes. Resources, pharmaceuticals and utilities are three sectors that currently offer outstanding value and, in the short term at least, equity markets look set to continue climbing the wall of worry."

Ian Vose, head of global developed markets at SWIP, on global equities:

"After an inauspicious start to the year, global equity markets experienced a renaissance in 2009. The impetus for the rally, which began in March, has been an improvement in economic data and signs that the banking sector, ravaged since the collapse of Lehman Brothers last September, is starting to find its feet.

"Despite the outlook for sub-trend economic growth in the medium term, free cash-flow yields in equities are attractive, particularly compared to government bond yields. The strong equity market rally has not left as many valuation anomalies. This leads SWIP towards a more concentrated approach to stock-picking as we enter 2010.

"In terms of specific opportunities, the Japanese market is an area of particular interest for the year ahead following its stark underperformance in 2009. We also believe that there are a number of investment opportunities in high-quality, large-cap defensive stocks. Again, these have recently underperformed, as investors favoured highly-indebted cyclical companies - even some with questionable business models."

Steven Maxwell, head of European equities at SWIP, on European equities:

"SWIP is bullish about the outlook for European equities. If the first few months of 2009 left investors bracing themselves for financial Armageddon, subsequent months have found them gauging how strong the recovery will be. This is a remarkable turnaround in sentiment.

"Over the coming quarters, we are likely to see earnings numbers continue to pick up. Valuations are not stretched, especially when compared to risk-free assets. We do believe, however, that 2010 will be a year for stock pickers. The rally of the last nine months was broad-based, initially characterised by the so called "dash for trash". We think that this phase is now over, and that good-quality companies will now come to the fore. This should play to our strengths at SWIP. Our portfolio construction in governed by our fundamental bottom-up investment process: we are stock pickers, investing in companies irrespective of their sector or where they are domiciled. Thorough balance-sheet and cash-flow analysis are the foundations of this method. This should allow us to find and invest in the companies that will provide the bulk of next year's returns.

"This has been an incredible year for European equity markets. From the depths of despair, the sector has found a new lease of life - and investors are once again embracing the asset class. Valuations should continue to rise over the next 12 months, with stock-pickers most likely to reap the rewards

Malcolm Naish, Director or Property at SWIP, comments on the global property market:

"In the UK, demand for good-quality investments are once again exceeding availability, with prices climbing as a result. Property companies, institutional and overseas investors are spending again and buying buildings at attractive prices. The key risk to the current UK rally is on the supply side - will the level of stock coming onto the market increase significantly? Here, the actions of the banks are crucial: they need to reduce their exposure to property. At the moment lenders are releasing limited amounts of impaired stock, but rising prices may encourage them to reduce their positions more quickly.

Weakness in the occupier market is the other caveat attached to the property market's strong recent rise. Pockets of distress still exist in the market, especially in Spain, Ireland and Greece. Although rental declines are moderating, rental growth may not turn positive again in many areas until 2011. As a result, better-than-expected returns over the next six months may be at the expense of the stronger returns we were expecting in late 2010 and 2011.

Looking ahead, companies will need to be confident about future economic conditions before they expand their businesses, increase headcount or look for new space. But while valuations and the cost of debt (where available) remain low, property is likely to continue to be attractive over the coming months. This is a great time to be redirecting funds back into the asset class; compared to cash and gilt returns, property looks good value."

Richard Dingwall-Smith, Chief Economist at SWIP, on the global economy:

"People have been obsessed with the shape of the recovery; will it be a W, a V, an L or a U? We look at things more simply. Do we think economic recovery will occur? The simple answer is "yes". We think growth is going to return to trend around the middle of 2010. We are already seeing some growth, albeit from a low base.

"The recovery is being driven by expansionary fiscal policy, low official interest rates, a gradual ending of the inventory correction and some revival of global trade. There are some headwinds to growth in 2010, arising from stretched household balance sheets and the need for banks to rebuild capital ratios. Nonetheless, we expect that global growth will gradually gather strength as next year develops and the capital spending cycle starts to turn up again.

"At the moment, the global recovery is progressing broadly as expected. GDP growth in the main advanced countries came in at 0.4%-0.5% for the third quarter (1.8% annualised), which is moderately below the pre-crisis trend rate. Survey data and leading indicators point to growth having continued at a similar or slightly faster rate in the final quarter.

"We are unlikely to see a return of the big gains enjoyed by any of the riskier asset classes in recent months, but a return to growth should underpin most markets in 2010, providing conditions in which investors can make money."

Graeme Caughey, head of Government bonds at SWIP, on government Bonds

"We believe there will be an increase in ten-year government bond yields over the next 12 months.  In the US, the strengthening economy, withdrawal of excess liquidity and start of an upward trend in the Fed Funds rate are expected to push the ten-year US Treasury yield to 4% in a year's time.  The upward move in the euro area is expected to be smaller than in the US, given a less robust economic upturn and a more delayed start to rate rises.  Our forecast for the ten-year Bund yield in a year's time is 3.6%.

"In the UK, there are a number of conflicting factors.  Net new gilt issuance in 2010 - 11 is likely to be less that the £225 billion scheduled this financial year.  But there is unlikely to be a repeat of this year's Bank of England purchases (amounting to at least £140 billion in the financial year) and indeed there may be some unwinding.  By this time next year the monetary policy committee is likely to have embarked on a series of official rate increases to keep inflation on target in the medium term. 
"We expect the ten-year gilt yield to be some way above the current level of 4.40% in a year's time."

Neil Murray, head of corporate bonds at SWIP, on corporate bonds

"The pace and magnitude of recent market gains have been unprecedented.  A rally that in normal conditions would take years to unfold has occurred in a matter of months.  At this point, valuations have reached broadly fair value considering where we are in the economic cycle.  However demand for corporate bonds from investors appears set to continue and provided the third-quarter corporate earnings season meets expectations, the rally could have further to run.

"Given the comparative returns available from government bonds and cash, corporate bonds still look attractive.  Nonetheless, the pace of the rally will probably slow and become more balanced.  There are still risks associated with investing in the corporate bond market; it is important to highlight that just as this was no ordinary recession, it will be no ordinary recovery."

Mark Harries - Multi-manager

"Unlike many, we do not think that there will much significant movement in equity markets in either direction next year. But a change in market leadership is now due. This is likely to mean that the large-cap growth sectors, such as pharmaceutical, tobacco, utilities and energy, will begin to lead the market. As investors focus on the end of the government's quantitative easing and the likely unfavourable growth outlook, there may be a significant reversal of fortunes for fund managers. Many of the star names left behind in 2009 may return to centre stage in 2010.

"Commodities look set to benefit from rising inflation, favourable government policies in the developed world and the rate of economic growth in the emerging markets. Here, China will play a key role. The huge urbanisation going on there means that the country consumes around one-fourth of almost any commodity going. Some exposure to this asset class makes sense in 2010. But as this has been historically a very volatile area there is a danger of overdoing things. An allocation of 5-10% should be enough to make a difference to portfolios.

"In the fixed-interest market, high-yield bonds have risen by around 80% this year, so investors have been taking profits. Most bond managers currently favour good-quality corporate bonds, which still offer attractive yields compared with many government-backed issues. Given their strong performance this year, we are somewhat cautious of both government issues and the high-yield area. Our focus remains with flexible and absolute return bond investors whom can benefit from varying market conditions.

For absolute return / hedge managers, the outlook is promising. Opportunities abound in currency, in yield curve positioning and equity long/short areas. With fewer market participants, political uncertainty, and volatile trading conditions, we are confident of some good returns here in 2010.

"Like all prudent investors, we have no desire to chase yesterday's great investment story. Investors should ensure that their portfolios are sufficiently broad to make the most of the opportunities that present themselves in 2010."