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OUTLOOK
2011 was not the year we expected. In the first six months asset
allocation mattered little as equities, corporate bonds and sovereign credit
all travelled upwards together. But by August the European crisis was in
full swing and the flight from risky assets to safer havens gathered
momentum. By the end of the year longer-dated government debt had
risen, in our opinion, to yet more expensive levels and investment grade
corporate bonds also had a good year.
Whilst we should not casually disregard the major events of 2011, both
natural and political, it is impossible to reduce the impact of the economic
situation in Europe. Indeed, it almost single-handedly determined which
asset classes did well last year and the crisis is hardly over. It is therefore
natural to expect the pattern of returns from asset classes to be repeated
during 2012. If the euro-zone deteriorates then is it a safer bet to hold US
Treasuries and Gold? But what if some sense of a lasting resolution is
discerned then shouldn’t equity markets rally? Whilst we agree that
investor sentiment could easily drive markets this way in the short term, it
is perhaps too simple. Even if a fix is found in Europe(by which we mean
there are no defaults by the peripheral economies and no large haircuts
for bondholders) Europe will have only bought itself time to deleverage.
OVERVIEW
Despite concerns about the health of the UK economy, it is not a foregone
conclusion that we will dip into recession during 2012. And if we do, it
is likely to be for perhaps only one quarter. If inflation does fall as forecast,
then hopefully the squeeze on incomes will ease and this could provide
some support. Contrary to expectations, the recent Purchasing Managers
Index numbers all rose which provides some comfort that UK activity hasn’t
completely stalled, although it was near zero last year.
The most obvious near term driver for the equity market is sentiment -
primarily a rerating of the market as a result of positive steps towards a
resolution in the euro-zone and a little more certainty concerning the euro.
This is, of course, a binary outcome and could drive markets lower if
improvements are not seen or if political resolve is perceived to be
waning.
It is wholly understandable that investors have become disillusioned in
what is now referred to as the lost-decade for UK equities – over ten years
of no capital return from their UK equity market investments. In our view
the valuation of UK equities makes them attractive for the long-term
investor. Ten years ago the price/earnings multiple for the UK market was
24x and today it is nearer 9x, but we fully acknowledge that it can of
course fall further and has been as low as 6x.
We believe that the Bank views deflation as a greater evil so we expect
rates to stay lower for longer. Nevertheless, the risk of a policy error is
high and the Bank will have to begin the process of normalising interest
rates at some point, although we do not now envisage an increase until
UK EQUITY MARKET
The US market ended the year roughly flat. However, it was a turbulent
year particularly in the second half - the market was down almost 20% by
early October. Downward revisions to second quarter Gross Domestic
Product (GDP) and fears of a consumer retrenchment, following a sharp
increase in the price of oil, shook investor confidence.
US economic data has been positive and is indicative of a growing
economy. The recent Purchasing Manager surveys have rebounded from
their Summer lows, and although the rate of unemployment is elevated,
monthly numbers are improving and there are tentative signs of a plateau
in the housing market.
It is positive that consumer confidence has surprised to the upside and
retail sales numbers have expanded, further supported by an increase in
consumer credit. We believe that the extremely accommodative
monetary policy, together with improving labour costs and the
entrepreneurial and innovative environment to be found in the US will
enable the country to be at the forefront of the western recovery.
It is likely to be an eventful year, both at an economic and political level.
US EQUITY MARKET
PAUL STEVENS,
Chartered FCSI
Investment Manager and Branch Principal
2012. In this ambiguous environment we expect the markets to be pron
to periods of uncertainty and volatility for a while longer yet.
Nevertheless, despite the languorous outlook for 2012, it is wort
highlighting the rude health of much of corporate Britain. UK balanc
sheets are healthy and profit margins are good. Opportunities for growt
are available in the faster growing global economies and we have see
dividends begin to increase. A lessening of pessimism surrounding Europ
could easily be the catalyst for a better year.
It is too early to predict who will be successful but as the race for Th
White House heats up, the focus on economic recovery will only intensify
MSCI WORLD EX USA USD & S&P500
A FUSION OF EXPERIENCE, TRADITION & INVESTMENT INDEPENDENCE
You may recall that in our last review we said that difficult decisions abou
public debt have still to be taken. Indeed, the western economies sti
remain impaired by growth restraining public and private debt. Growth i
needed to help reduce it. So whilst Europe spoilt returns for equity investor
in the second half of 2011, it simply does not follow that an improveme
in the European situation will create a sustainable rally in equity markets
Event risk will remain plentiful in 2012 and debt reduction and ban
deleveraging still remain the long-term headwinds to recovery. The worl
economy is fragile and interest rates will remain low and consequentl
investors will continue to search for yield, which may draw investors int
both equities and credit. However we believe that further evidence of
strong recovery in the US (which we anticipate) as well as a turn in Europ
is required to make any rally sustainable. Sufficient clarity on these issue
may not come until the second half of the year and until then investors ar
likely to sit tight in their US Treasuries and UK Gilts and
therefore the need for taking a longer term view remains as
essential as ever.
MSCI World ex USA TR USD: 0.31 S&P500 TR: 22.0
FTSE 100 & RPI TOTAL RETURN 2 YEARS
FTSE 100 TR : 10.17 UK Retail Price Index ex Mortgage Interest Payment: 9.30