By NIGEL PARSONS 02/02/2010
2009 - the year will inevitably be remembered as one of intervention and stimulus. To prevent the world sliding into depression, governments globally pumped in trillions of dollars of support. However, as authorities look for an exit strategy and the stabilisers come off, what does this mean for 2010?
Our Outlook
Our expectations for the early part of 2010 are for both growth and inflation to remain broadly in line with consensus. In the short term, there will inevitably be technical bounces in inflation as the increase in prices from the lows of last year filter through. However, as tax hikes hit home and public spending is cut in the second half of the year, we see both growth and inflation moderating. Any remaining stimulus will be biased towards the first half of 2010 and year-on-year increases in growth for economic data and corporate earnings should be expected over the next few quarters, given the poor state of the economy in the first half 2009.
Equities
Despite the extent of last year’s rally, valuations remain supported by both GDP and earnings growth, at least for the first half of 2010. Beyond this, weak final demand, increased margin pressure, poor demographics and large budget deficits are likely to result in several years of below trend growth in the West, with Asia and the Emerging Markets remaining the main drivers of growth.
A year for stock pickers?
Although we are indifferent between large, mid and small cap sized stocks on valuation grounds, we expect 2010 to be a better year for stock pickers. Whilst traditionally this favours small cap active managers, a mitigating factor will be the differences in local conditions and the prospects for UK Plc remain bleak. Accordingly, we will not be looking to increase exposure to small/mid cap exposure in the UK and see better opportunities overseas.
A renewed focus on stock picking is also likely to be positive for hedge funds, with long-short equity strategies benefitting in particular. In recognition of this, we will be increasing our hedge fund exposure marginally.
Fixed Interest
Amongst the main risks for 2010 is that the yield curve will shift significantly upwards, leading to a de-rating of all asset classes. Throughout 2009, much of the Government’s extra borrowing was absorbed by the Bank’s quantitative easing purchases, but this is due to end in February. The market will then have to absorb £225 billion of gilt issuance in 2010 alone. To put this in perspective, this is £5 billion more than was added to outstanding gilts during the entire period between 1980 and 1997.
Although we feel it is unlikely governments will allow this situation to spiral out of control, it seems inevitable that prices will have to fall to some extent to attract sufficient demand and indeed the yield curve has already started to drift upwards.
Asset Allocation Changes
We have highlighted previously that this will be the year that the stabilisers are removed, as fiscal discipline returns in the second half of 2010 and liquidity supplied through quantitative easing is turned off. Whilst corporate bonds still have sufficient headroom to absorb some increase in yield, this is limited and we have reduced our exposure slightly in recognition of this. We will also be looking to reduce our sterling exposure within fixed interest to protect against any possible downgrade to the UK’s credit rating. However, given 70% of earnings on the FTSE-100 are generated overseas we do not feel it is necessary to reduce the amount we have invested in UK listed equities, although larger cap stocks are preferred.
Having increased exposure to commercial property following our previous asset allocation meeting, we are not inclined to up this any further at present, as it is difficult to be more bullish given our concerns over UK Plc. For similar reasons whilst we are marginally increasing our equity exposure this will be consigned to UK large cap, Asia Pacific and the Emerging Markets. Although stock picking may be back in vogue in 2010, as markets trend in a tighter range, given our overriding concerns surrounding the future of the domestic economy, we prefer to gain exposure to this via an increased hedge allocation.
If there is anything you wish to discuss regarding this article please call one of our Advisers on 020 7189 9999.