The recovery in the global economy will continue over the coming months with most economies pulling out of the recession by the end of this quarter, according to Skandia Investment Grou
The recovery in the global economy will continue over the coming months with most economies pulling out of the recession by the end of this quarter, according to Skandia Investment Group.
SIG chief investment officer James Millard (pictured) says: ‘The global economy continues to recover. Equities have continued to rally with credit spreads narrowing. We think these trends will continue over the coming months. The green shoots that first appeared in the spring are now turning into something more substantive and we expect most economies to have pulled out of recession by the end of this quarter. Recent positive news from the banking sector has raised hopes that the worst of the banking crisis is behind us.’
Skandia remains overweight on equity markets. Equities are cheap against both bonds and cash and Skandia believes they should be well supported in the months ahead. Despite the recent rally, equities remain well below the levels seen before the collapse of Lehman’s in September. Given the improvement in both the financial market and economic outlook since then, markets have further room to rally.
Millard says that in terms of regional allocation, SIG continues to prefer Asia Pacific equities (ex Japan) but the least favoured region remains Europe. He says the firm has reduced the size of its US position as the recovery in growth might be more pronounced elsewhere. SIG remains overweight Latin America and has pulled the UK back to neutral.
Sharp production cuts over the last few quarters have succeeded in bringing inventory levels lower. Over the coming months and quarters companies are likely to increase production levels so that inventory levels do not fall too far too fast, says Millard. This has already started in Asia, while recent data suggests an increase in industrial production in the second half of 2009 in the Eurozone and the rest of the developing world.
Despite the improvement in a number of key areas, Millard says that the labour market remains weak in most countries and the US unemployment rate, in particular, continues to rise and is now close to the highest level in the post war period. Initial jobless claims in the US have narrowed over the last few weeks. However, the level remains very high and still consistent with an increase in the unemployment rate.
Millard says housing sectors in most economies remain weak, although activity seems to have bottomed in most countries. US house prices also remain weak with many indicators suggesting that prices continue to fall. However, he points out that May’s Case-Shiller house price index rose for the first time in three years suggesting the market may be close to the bottom.
‘While we continue to expect recovery, we remain conscious that the global economy remains fragile in a number of places. The banking sector remains weak, while budget deficits are at extreme levels in many places. In addition, recent increases in the price of oil have pushed up gasoline prices, putting downward pressure on real incomes. On balance, however, we expect the global economy to overcome these impediments and grow in 2009H2 and 2010.
‘Despite the improved growth outlook we expect core inflation levels to remain low and possibly fall further. This is because of the high levels of unemployment and low levels of capacity utilisation in the developed and developing world. This should allow central banks to keep interest rates at very low levels for a long term even if the economy recovers as we expect and commodity prices rise. Tighter fiscal policy from 2010 onwards should take some of the pressure away from the need for higher rates. Credit spreads have rallied sharply in the last few months. Despite this rally, they remain high by historic standards. Corporate profits are set to pick up as the economy moves out of recession,’ says Millard.
Millard says financials remain deeply unpopular, because of the ongoing concerns over likely loan losses and outlook for the global economy. He expects financials to perform well as the global economy recovers and banks are more than able to meet loan losses with gains from their operating activities. As confidence in banks increases, there could be significant inflows into this sector.
In the currency markets SIG expects recent trends to continue. Millard says exporting commodity currencies should be supported by the ongoing strength in commodity prices and expectations that some of these countries would be the first to start raising interest rates in 2010. SIG has downgraded the British Pound to neutral from overweight, following its strength over the last few months. The firm’s least favoured currencies remain the euro and the yen.
‘Consensus remains cautious, according to most measures. After increasing their exposure in equities to overweight the previous month, asset allocators took their equity exposure back towards neutral, according to the ML Global Survey 15th July. This slight reduction no doubt reflected an ongoing scepticism over the sustainability of the recovery. Investors remain cautious over the medium term outlook for economies and markets.
‘In terms of regional allocation, we are in line with consensus preferring Asia ex Japan, with continental Europe the least favoured. In terms of sector allocation, we are optimistic on the financial sector, while the consensus remains underweight. We and consensus continue to favour the usual cyclical stocks, such as materials and IT.
‘In terms of currency, we are broadly in line with the consensus. The euro is now seen as the most overvalued currency. The US Dollar outlook is broadly seen as fairly valued, with emerging market currencies undervalued,’ says Millard.