FYI | Jan 13 2010
By Chris Shaw
Following a very volatile 2009, Russell Investments expects 2010 will be more of a transition year, one to be made more interesting by the global economy’s move from recovery to an uncertain longer-term trend. To help guide investors the fund manager has put forward a guide to what it sees as key factors for the year ahead for a number of asset classes.
With respect to the shape of the economic recovery, the view of Russell Investments is -rather than a “V”, “U” or “W” shape- the square root symbol is possibly more accurate as it reflects the sharp fall and similarly sharp rise over the last year or so, followed by a relatively flat period that is likely to follow given current forecasts for the business cycle.
A “W” shape outcome is unlikely in its view as the amount of policy stimulus should support growth until consumers return more strongly, while the plus side of such a flat outcome is it will make the exit from low real interest rates and quantitative easing an easier process. Given such a recovery shape suggests some risk on/risk off behaviour in asset returns as future growth and earnings remain uncertain, Russell Investments suggests dividend stocks will likely be in favour with investors this year.
The answer to the inflation/deflation question according to Russell is likely neither, as fears of inflation running out of control don’t consider the tools the US Federal Reserve has available to it with respect to winding back the US$3.1 trillion increase on its balance sheet, while growth in broader measures of money have been moderate and this is of more importance with respect to inflation. On the flip side, the resolve of the Fed to avoid sustained deflation should mean no repeat of the problems Japan has faced over the past two decades.
The market is factoring in around 100-basis points of rate hikes by the Fed in 2010, but according to Russell Investments any increase in the cash rate is unlikely prior to 2011 as the economic recovery is likely to be a jobless one, with it possibly taking as long as a year between the time GDP growth turns positive and the resumption of a consistent trend with respect to employment gains of at least 150,000 jobs per month.
As well, the Fed can effectively lift rates by undoing quantitative easing measures rather than lifting the fund rate, especially as that will also help keep a relatively steep yield curve in place. This would help the banking system recapitalise and so reduce the number of bank failures.
A key feature of the current environment is it reflects a massive deleveraging process, with individuals consuming less and saving more, firms looking at strengthening balance sheets and financial institutions disposing of non or underperforming assets. This process will take some time and suggests growth will be lower as overall rates of consumption, borrowing and lending will be down from previous levels. If growth proves to be somewhat lacklustre Russell Investments suggests there is a risk investors will be disappointed, leading to a volatile year in risky assets.
For 2010 the fund manager expects the recent upward momentum in credit markets to continue, as while spreads should settle they are likely to remain at levels that will offer enough risk premium for holding as an asset class. Having said this, it looks like it will be increasingly difficult to justify an above weight holding.
Whether or not additional government driven fiscal stimulus measures will be needed in 2010 remains a difficult question to answer but of more importance, according to Russell Investments, is that the measures introduced to date are putting pressure on the income side of government balance sheets and if this is allowed to continue it will bring additional pressures in coming years. This suggests tension between the goals of more stimulus and reducing deficits, with how this is resolved likely to be of importance to investors in the coming months.
Asia continues to attract investor interest given the strength of its regional economy and Russell Investments sees this as justified given sharemarket valuations in the region don’t appear stretched and monetary policy is likely to remain at accommodative levels. This should create some asset price inflation before it shows up as higher consumer price inflation. Weaker exports are a risk, so while upside is expected, so too is volatility.
For commodities the long-term story remains ongoing demand from China and India, but according to Russell Investments the shorter-term issue is the potential for investors to ignore rising inventories and sluggish demand growth from the developed world in their desire to gain exposure to this longer-term story.
For gold specifically Russell suggests the support given it by investor fears of a downturn and a weaker US dollar during 2009 are likely to be less supportive this year, meaning it looks little like a safe haven asset at current levels as the uncertain outlook means the precious metal could just as easily fall to around US$600 per ounce as rise to around US$1,800 per ounce.
While a significant rebound in the US dollar is not expected this year, Russell Investments takes the view the current levels of pessimism surrounding the currency is overdone as the US dollar is already very weak and further falls require an appreciation in other currencies, an argument hard to make for the euro, British pound and yen. This could make the US dollar one of the better performing currencies almost by default, especially if the US economy continues to recover gradually, so increasing the likelihood of Fed rate hikes early in 2011.
In summary, Russell Investment suggests investors should take a patient approach to 2010 given the number of uncertainties impacting the present investment environment, with a well diversified portfolio likely to generate reasonable returns if the lessons of 2009 are heeded.
