The economic downturn gathers pace
03 April 2008
Politics and patience may be the watchwords for investors in the next few months, according to analysis published today by leading investment house, Standard Life Investments.
In the latest edition of Global Outlook, its quarterly investment view, Standard Life Investments considers which official measures are taking effect and what more needs to be done in order to find a resolution to the current financial crisis.
Andrew Milligan, Head of Global Strategy at Standard Life Investments, said:
"In recent weeks, policy makers in most of the major economies have admitted that not only will the US be in recession in 2008 but that global activity will be subdued well into 2009. Consensus expectations are that the US will experience flat or negative growth in the first half of this year, some recovery in the second half as the Congressional $170bn fiscal stimulus package takes effect, but continued weakness next year reflecting the ongoing contraction in credit, both to households and companies. Similarly, more investors are beginning to realise that the outlook for most of the major economies is a prolonged period of sub-trend growth.
"Financial markets have been severely affected as investors try to get to grips with much lower earnings growth, significant bad debt write offs, and even a growing sense of uncertainty about the very future of some companies. As a result, on many valuations measures there are now attractive opportunities across a range of markets: equities such as certain financials or house builders, credit such as some high quality investment grade debt, property such as various real estate investment trusts. The key issue for investors is what expectations are currently in the price.
"There has been a degree of good news during the past quarter. The authorities have begun to react to the growing pressures, often as they realise the impact on jobs. Examples of policy responses include: a swift merger for Bear Stearns, more support for IKB, and the 'temporary' nationalisation of Northern Rock. More important still are the regulatory changes and the new lending facilities available from the Fed and other central banks.
"But this is only a job half done. Few of these measures address the fundamental problems undermining the business model of many firms across the financial, house building, real estate and broking sectors. Importantly, despite Fed rate cuts, the price and availability of credit have generally deteriorated, not improved.
"These are global problems but it is not easy to see many global solutions. Most noticeably, other OECD central banks remain much more concerned about deteriorating inflation expectations than does the US Fed. A related issue which investors should focus on is the inflationary pressures being seen in the emerging market economies. The same food and energy problems causing concern in the UK or the US feed through even more severely in the family expenditure baskets of say India or China, where headline inflation is running about 6-7% a year. We continue to warn that corporate sector margins are under pressure, while investors remain over-optimistic about future earnings growth. Expectations for global earnings growth over the coming 12 months remain about 11%, which we consider to be too high against our forecasts of below trend activity. Downside risks to such forecasts are likely to worry investors for some months to come.
"Politics and patience may be the watchwords for the next few months. As the pain has built up across the financial sector and the real economy, politicians have started to respond. The dangers are particularly clear to the US Congress in an election year! Nevertheless, there are by no means any easy political solutions. Proposals such as the Frank-Dodd plan to assist the US mortgage market face detailed problems stemming from an opaque, complicated financial system, as well as major question marks about moral hazard and future costs to the taxpayer. Investors also need to keep a watchful eye on 'self help' measures across individual firms and sectors, for example cost cutting, capital raising, or divesting operations. Once assets become cheap enough, the key Focus on Change question becomes why will the market change its mind."
