Investors are currently more focused than ever on the US economy. According to Mark Burgess, Chief Investment Officer at Threadneedle, this follows comments from the Federal Reserve indicating that signs of the recovery gathering momentum would lead them to “taper” the level of quantitative easing, from the current rate of $85bn per month. Consumer confidence and expenditure are reasonably healthy and the housing market has shown a strong recovery, although this has been driven more by investors than occupiers. Employment is growing at a steady pace and whilst corporate capital expenditure has been disappointing, we anticipate some acceleration in the second half of the year. Our confidence in the US recovery is growing.
In contrast to the US, the eurozone shows little sign of improvement, with the French economy showing greater weakness than had been anticipated. Furthermore, recent yen depreciation will be an added headwind for exports, particularly from Germany.
We see very pedestrian growth in the UK at just 1% this year. Employment is showing reasonable growth, the housing market is improving and consumption is satisfactory despite pressure on real disposable income. The largest issue for the economy is the export market, which is heavily biased towards the weak eurozone. This will continue to be a drag on the UK’s performance
Japan’s economyis already responding to the massive package of quantitative easing, fiscal injections and other measures aimed at ending deflation and stimulating growth. Consumption has improved, exports will benefit from yen weakness and the increasingly likely plan to restart some nuclear generation would give a useful boost to the trade balance. We have an above consensus forecast for Japanese GDP growth this year and next.
These varying economic environments around the globe lead us to adopt more of a regional equity strategy than previously. In the US, we have added to domestic cyclicals, especially housing related stocks, and are cautious on many defensive sectors such as utilities. In the UK and Europe, we are generally more cautious on cyclicals and are looking to add to some steady growth stocks, e.g. consumer staples, which have recently suffered in the market correction. In Asia, we favour cyclicals exposed to the US, such as technology companies, but are wary of some of the China exposed cyclicals, such as steel stocks. In all areas, good growth companies and those with high and growing dividend yields are likely to be in demand.
The recent talk of tapering by the Federal Reserve has sharply increased market volatility in all asset classes. Quantitative easing has been a huge force in driving markets and traditionally the start of a cycle of monetary tightening has been a difficult time for investors. However, tapering is only a reduction in the level of the Federal Reserve’s monetary stimulus, not a traditional tightening. We expect official interest rates to remain extremely low for an extended period. The Federal Reserve’s action would be on account of improved economic momentum, and we believe that there will be very little inflationary pressure in the short term. This combination of better growth, low inflation and still stimulatory monetary policy should be a reasonable background for equity markets. We remain above benchmark in equities and have used the recent correction to increase our Japanese exposure, moving to an overweight position. This reflects the recovery potential we see for corporate profits in the new world and “Abenomics”.
Government and investment grade bond markets, on the other hand, are showing very limited long-term value and therefore appear vulnerable if the growth outlook improves. We have been well below benchmark in government bonds for some time but have recently reduced our exposure to investment grade corporate bonds, where spreads are likely to offer only limited protection in the event of rising government yields.
We expect income hungry investors to continue searching for yield and assets that have lagged other markets in recent years. In addition, the issue of refinancing of UK properties that has hung over the sector for a long period is now underway. We have added to UK commercial property, moving to a small overweight on a medium-term view.