Iain Stewart, manager of the Newton Real Return Fund, looks at the challenges facing investors over the coming year.
“As we enter 2011, the economies of the Western world are still staggering under the weight of too much debt. The aggressive and unprecedented policies put in place to alleviate the symptoms of indebtedness have, however, been successful – in the short term at least – in creating some momentum in the mature economies,” says Stewart. “This, combined with the dynamism in the rest of the world, offers the prospect of respectable economic growth, at the headline level, in the near term at least.
“The efforts of authorities around the world, despite being largely parochial in nature (particularly in the US), have been even more successful in energising financial markets, although we remain concerned that ultra-loose policy has led to a widespread mispricing of risk,” he continues. “Barring the emergence of further new crises, 2011 could mimic 2010 as a volatile, but ultimately constructive, year for ‘risk’ assets such as equities. However, we would stress that this potential scenario is by no means certain and would represent the continuation of a cyclical bull market from the lows reached in March 2009. The structural impediments are so significant that further difficulties should not come as a surprise,” Stewart adds.
“The inflationary bias of economic policy strongly suggests that the balance of risks favours equities – given that corporate profits and dividends can grow in line with nominal GDP – over government bonds, on which coupons are fixed and barely cover the inflation that investors are now faced with,” explains Stewart. “The risks that bond yields rise, despite the quantitative easing-related efforts of central bankers, and that growth remains positive mean we continue to favour credit risk, particularly specific high-yield corporate issues over investment-grade equivalents, Western government debt or emerging-market sovereign bonds,” he adds.
“In the equity markets, the monetary backdrop can continue to support cyclical and commodity-related sectors, although we continue to believe that the stocks of companies with stable earnings look particularly attractive given current valuations and yields.” He continues, “Moreover, the very palpable structural risks and the likelihood of continued volatility suggest that investors may be increasingly wary of over-exposure to the riskiest sectors. That said, the understandable suspicion that current monetary policies are aimed partially at ‘inflating away’ debt problems should keep investors interested in real physical assets, such as commodities, particularly where the supply is controlled or restricted,” Stewart explains.
“Meanwhile, currency markets are likely to be a major mechanism through which global realignment can take place. In the long run,” he says, “the trend favours currencies in the emerging world over those in the indebted west, as well as commodity-related currencies, particularly those in economies where governments are well financed – such as the Norwegian krone and Canadian dollar. This trend will, however, take the shape of anything but a straight line; as such, active management of currency exposure will remain an important component of returns over the coming year,” Stewart concludes.
