FYI | Mar 10 2011
– Russell Investments expects volatile markets in 2011
– Forecasts modest gains for equities
– Less cautious on Australia relative to rest of world
By Chris Shaw
Equity market forecasts for 2011 have included some optimistic estimates, with top of the range targets of 1,500 for the S&P500 in the US and 5,600 for the S&P/ASX200 (if not higher). Russell Investments suggest more measured performance is likely.
Russell Investments chief investment strategist, Andrew Pease, expects volatility will be an ongoing market theme in 2011. This reflects the view the European debt crisis has no easy solution, as well as the uncertainty caused by a heating up of geopolitical issues in the Middle East and Northern Africa region (MENA).
As a result, rather than returns of better than 20% implied by top of the market forecasts, Pease expects share market returns in the high single to low double-digit range. This implies year end targets of 1,350-1,400 for the S&P500 and 5,000-5,200 for the S&P/ASX200.
A central feature of Pease's forecast for equity markets is the expectation the US economy will deliver growth of 3.0-3.5% this year. This is close to long-term trend rates and should mean reasonable growth in corporate earnings, but it won't be enough to significantly impact on unemployment. This means the recovery from the financial crisis is likely to be drawn out.
Given the level of spare capacity in the US, Pease suggests risks to growth forecasts for the US are skewed to the upside. Growth of 4.5% is more likely than growth of 1.5%, but a number of headwinds such as de-leveraging, mortgage foreclosures and cuts in government spending will limit potential upside.
The issue with respect to share market returns is the level of profit growth still to be generated by the US recovery. While reasonable earnings gains appear possible, Pease notes earnings per share for S&P500 companies in the US rebounded by nearly 40% in 2010.
In 2010 Russell Investments was cautious on Australian equities but this year Pease sees reasons to be less cautious relative to the rest of the world. A high Australian dollar and potential for more hikes in interest rates are headwinds, but Pease expects benefits from a mining-led investment boom and income gains from high commodity prices.
Australia remains a two-speed economy though in Pease's view, the mining sector continuing to boom while outside the mining sector firms remain cautious on investment spending and households are repaying debt rather than consuming.
Interest rates are likely to go higher, but while the market is pricing in three further 0.25% rate hikes by year's end Pease sees the next rate increase as being pushed out to the extent 2011 may see only one or two more hikes.
Any Chinese economic slowdown is yet to materialise, Pease seeing current policy debate as centred on whether the spike in inflation is temporary or an indicator of an overheating economy. Consensus opinion at present favours the view inflation will moderate, but Pease suggests there remain the risk further aggressive policy tightening induces an economic slowdown later in the year.
With respect to emerging markets, Pease points out the 19% gain achieved by the MSCI Emerging Markets index in 2010, which followed a 79% gain in 2009, means valuations are no longer so supportive. Inflation pressures are likely to be the biggest issue for emerging market economies as it may prompt policy tightening, a process already underway in China and other countries.
In fixed interest, Pease sees a two part story, with high yield and investment grade credit still attractive but global government bonds somewhat expensive at current levels. There remains some upside risk to US bond yields, Pease seeing scope for yields on 10-year bonds to hit 4.0% this year from 3.6% at present. Australian government bonds looks fair value in Pease's view.
Pease's conclusion is the combination of a moderate US economic recovery and reasonable equity market valuations points to a modest positive bias for sharemarkets, but likely volatile conditions mean investors will be challenged to maintain discipline over the course of the year.
