3rd December 2012
Fund manager Threadneedle says the economic situation will remain very challenging next year, but it has suggested sectors and even stocks that should continue to prosper in this environment.
In a note from chief investment officer Mark Burgess and his team, the manager notes that returns from both equities and corporate bonds have been positive this year demonstrating that they are not necessarily linked to GDP growth at least not in the short term. We have broken the manager's view down into a series of key quotes and what it sees as the outlook for the global economy, markets and assets including its favoured markets and stocks.
The euro crisis:
"In the eurozone, there is now at least recognition that very tough decisions lie ahead. As a number of European politicians have indicated, they all know what to do to address the debt crisis, they just don't know how to get re-elected if they do it. The overhang of national debt will cast a very heavy shadow for an extended period, and for this reason we remain cautious on companies that are heavily reliant on government spending."
The US fiscal cliff:
"We believe it is very unlikely lawmakers will actively try to legislate another recession."
Equities in general:
"The scope for earnings to disappoint even as macroeconomic tail risks appear to be abating highlights the importance of making the right stock selection calls, as well as investing in the most appropriate blend of assets for a given risk/return target."
"There will be bumps in the road as stock markets react to the latest policy initiatives and developments. At a micro level, we expect the strong to continue to get stronger and M&A activity will remain an important driver in a number of markets as companies put their excess cash to work."
"We continue to question the appeal of so-called safe haven core government bonds such as UK gilts and German bunds. Yields remain at historically low levels (and are particularly unattractive in real terms) and the risk of capital losses down the road is significant. The US Treasury market faces similar concerns, although the continuation of QE by the Fed means that yields are unlikely to balloon in the short term."
"We are cautious on UK commercial property as demand remains weak outside of the ‘super prime' sectors such as West London offices. In commercial property markets, we expect income to be the primary driver of total returns as occupational markets remain weak and the problems in sectors such as UK retail are well known, with a number of household names going to the wall over the past year."
"We expect commodity markets to be pulled in different directions in 2013, with the latest round of QE most likely to benefit precious metals. We see tight supply conditions in the oil market, and a shock to production can't be ruled out given Middle East tensions. Buoyant agricultural markets should lead to heavy planting, which may limit future gains. And the sluggish global economy and the shift in China from investment-led growth towards greater emphasis on consumption are negative for industrial metals. However, even with these caveats, commodities are likely to remain very popular among investors looking for a hedge against the longer-term inflation risks posed by QE."
"Successful active management is likely to be a more significant determinant of returns in 2013 as valuation concerns create headwinds for a number of fixed income markets. In short, it will not be as easy to make money in fixed income in 2013 as it was in 2012."
"In the equities space, shares in large-cap, high-yielding companies with strong balance sheets, robust cash flow generation and proven capital allocation strategies are also likely to remain in demand, particularly as the shares in such companies often provide a higher yield than their bonds."
Emerging market debt:
"In emerging market sovereign debt, there will be an increasing realisation that certain sovereign issuers are more deserving of ‘safe haven' status than their developed market peers. Typically, emerging market economies are characterised by superior growth, relatively low debt and high FX reserves. Turkey's recent upgrade to investment-grade status by Fitch is one indicator of how far the emerging economies have come. Emerging market corporate bonds can also provide a useful pick up in yield for investors, and in most instances issuers are supported by discernibly better economic fundamentals than those prevailing in the developed world. Given current levels however, there is likely to be a limit to how much further EM spreads can tighten in 2013."
"UK property continues to offer a decent pick up in yield over gilts but overall demand for property remains weak and significant refinancing needs to be undertaken. In this environment, those property funds focusing on sustainable but higher-than-average yields and possessing the firepower to take advantage of distressed valuations should be well placed."
Strong companies continue to get stronger:
"In terms of equities, we continue to expect the strong to get stronger in 2013. Poor management, flawed business models and weak franchises are very likely to struggle in the tough economic environment, while proven management teams with strong franchises should prosper. Many of these quality companies are inexpensively valued, affording them significant scope to outperform. Examples we currently hold include
Nestlé – as we think it has an exceptionally strong balance sheet, a high yield and category-leading products in a relatively defensive sector, with good exposure to EM growth.
Reed Elsevier – this high quality media company has high returns, exceptional cash generation and a strong dividend. Current valuation does not fully reflect this and we believe that the well regarded, relatively new management team will continue to deliver and ultimately create value for shareholders."
The US market is best:
"In terms of markets we particularly like, the US offers an attractive mix of quality management, high free cash flow generation and defensive growth. The country is also benefiting from growing independence in energy due to the development of shale gas."
The sort of companies, Threadneedle likes providing growth in a growth free world:
"Companies selling into emerging markets, such as European car maker VW
businesses with access to a secular theme such as the provision of cost-effective healthcare services to ageing populations. For example, Davita of the US or Fresenius Medical in Europe
companies with superior products or intellectual property that should help to cushion them from the economic cycle, such as Apple.
Government bonds – risk-free return or return-free risk:
"The sustainability of AAA sovereign credit ratings in the developed world will remain a source of consternation in 2013, both for the ratings agencies and investors. The potential for further gains from core government bonds is limited and the risk of loss is significant, given that yields have a very long way to rise before they return to long-term averages. In this environment in
vestors seeking low risk assets will have to look beyond core government bonds, and absolute return approaches are likely to remain popular."
Stay selective in commodities:
"For investors in commodities, a selective approach will remain critical in 2013. Commodities where supply and demand dynamics are tight, such as oil and related products, should offer better prospects than areas that are tied to the strength of the global economy such as industrial metals. However, we remain cautiously optimistic for global growth in 2013 if the US government can handle the debt ceiling and fiscal cliff issues in a timely manner, combined with the potential for new growth prospects in China following the leadership handover in Q1. Overall though, oil and related products also provide useful protection against any supply shocks or political concerns in the Middle East, as Saudi Arabia continues to play the key role in balancing global oil markets. Shale gas will remain an important theme in the US (indeed the US has already been dubbed ‘Saudi America'). However as shale gas cannot be exported, this will be a purely domestic US story."
"The outlook for gold remains constructive into 2013 due to a number of continuing factors. Low real interest rates globally and rounds of QE in most major economies both provide incentives for investors to hold gold as a hedge against currency debasement. Central banks, especially of emerging market countries, also continue to be buyers rather than sellers of gold bullion in conjunction with Gold ETF volumes maintaining their steady march upwards. The only headwind to gold remains the strength of the US economy relative to Europe and its various debt issues. With the positive economic outlook and the current dislike for the Euro as a reserve currency, the USD should see appreciation on a relative basis. This will serve to prevent gold prices from moving upwards too fast, but won't stop its gradual appreciation towards $2,000/oz."