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Expect a bumpy road ahead, says Newton’s James Harries

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James Harries, manager of the Newton Global Higher Income Fund, believes 2011 will be a year dogged by market and economic uncertainty. 

“Global capital markets appear confused,” says Harries. “Government bond yields are matching Great Depression-era lows, while the gold price is at an all-time high and other industrial commodity prices are soaring. Less than two years after the biggest debt crisis in history, investors are showing renewed enthusiasm for 100-year corporate bonds. These anomalies result from the sheer scale of monetary and fiscal stimulus implemented in the world’s major economies. The current economic and market backdrop must be viewed through the distorting lens of these policy settings.”

Harries says the consumer in both the US and elsewhere in the developed world remains under pressure despite the efforts of the authorities to stimulate demand. Furthermore, as US interest rates and bond yields provide the benchmark for the cost of money everywhere, looser US policy and its distortions are exported worldwide. 

“The potential distortions do not end there,” says Harries. “With the arsenal of conventional monetary policy all but exhausted, additional stimulus is likely to take the form of more unconventional policies, such as quantitative easing. This unconventional policy is likely to further distort bond markets and capital allocation in economies far and wide. Such policy is likely also to boost investor interest in real assets (such as gold) and ultimately undermine the value of, and confidence in, the world’s reserve currency, the US dollar.”

Developing world consumption is widely regarded as the world’s most exciting longer-term growth opportunity. Capital has been channelled into these regions, causing their equity markets, real estate sectors and, in some cases, currencies to rise. Harries believes this trend looks set to continue and, if more money is printed in the West, developing world assets, along with the commodities that fuel their growth, are likely to be the epicentre of the world’s next financial market bubble.

“The rebalancing of economic models is, however, a multi-year process,” says Harries, “not least because, in both the developed and developing world, these adjustments – consuming less and saving more in deficit economies, and exporting less and consuming more in surplus economies – are likely to hamper short-term growth. Further bumps in the road are to be expected, perhaps imminently.”

The most obvious risk facing investors is that overtly reflationary policies succeed in creating inflation. Harries says this is already the case in the developing world, where policymakers are often reluctant to raise interest rates, fearing further capital inflows and currency appreciation; something no economy seems to want in the current climate.

“Post-crisis policies are likely to lead to isolated ‘inflations’ – in the developing world and real assets – rather than generalised consumer price inflation,” he adds. “Meanwhile, we expect generalised inflation to be held back by weak domestic wage growth in the developed world, something which already seems to be playing out. Ultimately, more widespread inflation is likely if policymakers feel compelled to support their flagging economies with newly printed money.”

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