Standard Life Investments (SLI), the global investment manager, believes that there are signs of improvement in the debt deleveraging cycle, especially in the US, while warning that the process remains a long and complex one after such a major financial crisis.
In the latest edition of Global Outlook, Standard Life Investments highlights that one of the key features differentiating this business cycle from most of its predecessors has been the extent of the build up and then slow pay back of sizeable amounts of debt by the private and public sectors. As history has demonstrated, such a deleveraging process can take many years to unwind, during which time consumption, output and productivity tend to grow more slowly than normal. But seven years on from the 2005 peak of the US housing market, there are now signs that the worst of the US deleveraging is coming to an end, although conversely the situation remains difficult in Europe.
Andrew Milligan (pictured), Head of Global Strategy, Standard Life Investments, says: “The evidence is building that the US has entered a new, better, phase of deleveraging. Indeed, the housing sector could be on the brink of contributing positively, if modestly, to GDP growth for the first time since the recession ended. The triggers for further improvement include enhancing the viability of the banking system and keeping monetary policy accommodative, with nominal interest rates well below nominal growth rates. At the margin the ability of more parts of the private sector, especially smaller businesses, to gain access to credit should make the US economic recovery more sustainable. This in turn would support further exposure not only to US equities and corporate bonds but also those economies, mainly in parts of Asia and Latin America, with strong trade links with the US and viable banking systems in their own right.
“Nevertheless, risks still remain – part of the resolution to the private sector’s excessive leverage has been transferring it to the government, and the legacy of dealing with that debt burden will last at least the coming decade. The results of the upcoming US elections will be important.
“Standard Life Investments believes much good news has been priced into markets but we still see favourable prospects. US share prices have rallied off their November lows, led in large part by the financials sector. We remain Heavy in the large US banks, only trading at a 0.7x relative P/E multiple which is in line with longer term averages. Improvements in the US housing picture have been an important element to the rerating of the banks since the tail of mortgage liabilities is becoming less severe. Nevertheless, we can see a degree of caution is still priced into this sector.
“We continue to favour sustainable cash flow through a mixture of equity, credit and real estate assets, on a diversified geographical basis. In an uncertain world, investors should base their portfolio decisions on their strongest convictions. For Standard Life Investments, this is a preference for corporate bonds versus government bonds, and US and UK equities over their Japanese and European counterparts. Our strongest conviction position is to be Very Light in government bonds. Within commercial property, we favour North America and parts of the UK market to those in much of Asia and Continental Europe. Our current House View has been built on the belief that policy makers will maintain a supportive monetary policy and, as a consequence, that the corporate sector will continue to make profits.”