Our forecasts for economic growth in the developing world have consistently been materially higher than those for the developed world. We have also seen fairly steady downgrades to our expectations for growth in developed economies for some time. That environment now appears to be changing a little as we detect some signs of better news from a number of developed countries, while many emerging economies are experiencing a harsher background.
We remain keen on high yielders, as long as they are supported by growing cash flows.
In the US, we see fairly healthy economic momentum driven by a good recovery in consumer confidence. Corporate spending remains slow, despite strong balance sheets, but we expect a pick-up as managements become more confident of growth, and the average age of equipment becomes even longer. In light of this improvement and to avoid the risk of inflating bubbles, the Federal Reserve has discussed “tapering” its quantitative easing (QE) program, causing a material rise in bond yields which, in time, will push up financing costs for many borrowers, particularly in the all-important mortgage market. However, we believe affordability remains good and do not expect recent moves to derail the recovery.
In the euro area we see marginally better news,but clearly from very depressed levels. Germany remains relatively healthy and we now see less negative manufacturing and consumer confidence surveys from the periphery, with Spain and Greece worthy of note. In the UK, the housing market and consumer expenditure appear reasonable and we anticipate some recovery in construction and North Sea Oil output in the second half. There is little sign of an improvement in exports but a strengthening US economy could improve matters. We currently believe that the risks to our forecasts lie on the upside.
Pharmaceuticals appear more attractive than for some time with new approvals rising and the number of potential areas for new drugs growing.
In Japan “Abenomics” is already having a worthwhile impact.Consumer confidence is up significantly, the trade balance has improved, business confidence shows some recovery and consumer price changes in general have moved up to around flat. We have raised our GDP forecast for Japan for this year to 2.5%.
Conversely China is suffering from demographic issues, inflation risks and the desired shift in the economy from investment to consumption is proving hard to engineer. In addition, the authorities appear determined to resolve the problems caused by the secondary banks, leading to a short-term credit squeeze. In this environment, we are more cautious on growth in the immediate future.
Spreads on corporate and emerging market debt have risen materially and appear relatively attractive.
Despite the dramatic moves in many asset prices, we have made no material changes to our equity strategies. We remain keen on high yielders, as long as they are supported by growing cash flows. We look for growth opportunities and can identify beneficiaries of the US recovery. We believe that the strong will get stronger and appropriate M&A activity can be beneficial. Rising bond yields will make high yielding equities that are regarded as bond-proxies less attractive, but we have never been enthusiastic about this type of stock. Within defensives, pharmaceuticals appear more attractive than for some time with new approvals rising and the number of potential areas for new drugs growing.
We believe that the reasons for tapering, reflecting a more robust US economy and to reduce the risks of financial bubbles, are benign. Clearly many asset markets have benefited from QE, which will decline, albeit gradually. Inevitability investors in some risk assets feel that safer investments, now with higher yields, appear a better alternative. This may cause further short-term volatility. However, the growth environment and corporate earnings outlook are reasonable and valuations have improved. We will seek opportunities to add to equities on setbacks. We expect official interest rates to remain unchanged for some time in major markets and, although yield curves could steepen further, we do not forecast a significant rise in government bond yields in the near future. Despite this, we remain underweight due to valuation levels. Spreads on corporate and emerging market debt have risen materially and appear relatively attractive. Again, further weaknesses in these assets could offer buying opportunities.
Opinion column by Mark Burgess, Chief Investment Officer at Threadneedle