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Tepid recovery dampens inflation risk, says Barings

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The threat of inflation may be further away than many have been predicting, according to Baring Asset Management’s latest global economic research. 

This, coupled with continued super-easy monetary policy and slow growth, suggests that while the prospect of a tepid recovery remains intact, economic conditions are unlikely to normalise until the latter part of 2010.

Andrew Cole, director of asset allocation at Barings, says: “We believe that inflation is unlikely to cause a problem in the short term. In light of this, monetary policy is likely to remain super easy for some time to come. We had been expecting the first tightening moves during the first half of 2010, but with economies still running well below even their reduced potential levels next year, even the second half looks far from certain. Recent data in the US, Europe and the UK shows credit formation in the private sector remains negative and this might well cause further tranches of quantitative easing to be released.”

Barings believes that while this may be bad news for the real economy, financial assets and investors may benefit. 

Cole says: “A delayed pick-up in inflation is good news for bond markets.  Equities would also benefit from strong savings flows into the asset class, and a potential re-rating on what would likely be a steady if unspectacular uptrend in corporate profits.”

Barings is skeptical of a normal recovery path out of recession, which would typically see five to six quarters of growth at around five to six per cent in GDP terms (annualised), as this will be constrained by personal balance sheet issues while the weakness of bank balance sheets will curtail lending.

In light of this tepid recovery, characterised by super easy monetary policy, Barings’ investment strategy is skewed towards risk assets over the next twelve months. In the short-term, however, Barings is backing away from this view in favour of a more defensive stance.

Cole says: “Markets have run very, very hard, giving us one of the strongest six month return figures ever recorded in the last hundred odd years. Our dividend discount models no longer show equities to be cheap, and they are beginning to rely on quite an optimistic rebound in earnings. We are convinced that a pause is not far away. An equity set back could also make the entry point for high yield bonds more attractive.

“We have downgraded government bonds because we have seen a modest rally and now both the US and, even more, the UK look vulnerable to the huge issuance we are likely to see over the next year. We prefer bunds where accounts need some insurance and Australia where the back up in yields already discount a pretty normal recovery.”

Barings has managed the exposure of its multi asset portfolios in light of this return to a more defensive stance. 

Cole adds: “To balance the move on bonds and equities we have temporarily increased our allocation to cash and gold bullion to provide a haven from which we expect to deploy risk assets later in the autumn.”

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