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Markets responding to aggressive action taken by authorities, says Barings

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There are strong signs that markets are responding to the aggressive action taken by authorities to address the global economic crisis, Baring Asset Management’s latest global economic

There are strong signs that markets are responding to the aggressive action taken by authorities to address the global economic crisis, Baring Asset Management’s latest global economic research suggests.

Andrew Cole, director of asset allocation at Barings, says: ‘Initially markets were unmoved by the government’s plans for quantitative easing that involved two tranches of GBP75bn in government and corporate bond purchases. The very lack of any meaningful response to such a dramatic event is in itself testimony to the incredibly depressive state of market psychology. Fortunately this did not last long. Since then, leading banks have announced trading statements highlighting conditions have significantly improved. The Fed has announced plans to embark on another round of quantitative easing along with plans by the US Treasury Secretary Tim Geithner to purchase toxic bank assets. This has all led to sharp rallies in UK and US government bonds, while credit spreads have come in and equities have bounced significantly from the lows.’

Barings’ multi-asset strategies have been reallocating to equities since October 2008 as markets began to recover from their position of panic that followed the collapse of Lehmans. Analysis of risk premia following the recent bounce continues to support the increased exposure to risk assets and Barings continues to build positions with an increased focus on stock selection.

Cole says: ‘We are now stress testing the data with a profit fall of 30 per cent for 2009 and another 30 per cent for 2010, followed by a resumption to trend earnings at a nominal five per cent in line with a prudent GDP growth forecast. Even with these cuts in profits, equities are showing a modest risk premia, especially in comparison with cash or government bonds. When the rebound does come, it is our expectation that those companies that have survived the downturn will see a more significant recovery in earnings not least because they will face less competition for a few years, have made considerable cost savings and will likely have greater pricing power.’

Barings believes dispersions in country and sector returns will be much narrower in 2009 and 2010 than it has seen in recent years.

‘Stock selection has the potential to provide a greater contribution to returns in the recovery,’ says Cole. ‘Equity managers should be asking themselves do they have the right bank, or the right oil company, and focusing less on whether their exposure to financials is high enough. Which stocks owned and which avoided will matter.’

Barings’ research highlights that convertibles and corporate bonds are still attractive, although in the long-term they are cautious on the interest rate risk within these two asset classes. Similarly they are negative on government bonds although they recognise that yields will not rise soon whilst quantitative easing is in place. Barings remains bearish on sterling and the dollar and continues with a positive view towards gold.

While data from the real economy continues to paint a dire picture for the economy currently, the market is starting to look forward. Barings believes the current consensus for the later part of 2009 and 2010 may be unduly pessimistic. 

Cole says: ‘In some countries the policy frame-work has been muddled which has led our recovery scores to have been trimmed back but this is more a case of delaying rather than cancelling the bounce. It is hopeful that greater clarity will emerge following the united pledge last week by world leaders at the G20 summit in London to tackle the global downturn with a USD1,100bn package.’

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