Threadneedle’s outlook and investment themes for 2011


Reasonable global growth led by emerging economies, but markets remain fragile and shocks will trigger volatility

Mark Burgess, incoming Chief Investment Officer at Threadneedle, looks ahead to 2011: “Our central case for 2011 is one of reasonable global growth led by emerging markets. Against this backdrop world equity markets look good value, particularly against government bonds. In addition, many companies have strong, healthy balance sheets and are sitting on large cash piles, having held back on investment during the recession. We expect corporates globally to start to use this cash to increase capex, raise dividends, buy-back stock or undertake merger and acquisition activity. We believe that emerging markets will continue to grow and outperform the rest of the world, helping to fuel demand for consumer goods and commodities.

“At the same time we must be mindful of the risks to this scenario. The credit crisis elicited a range of untested policy responses and we are yet to see the full consequences of these policies. The banking sector globally needs to continue to raise capital, which will restrain credit expansion and hence economic growth. In emerging markets there is the potential for growth to turn into a bubble and inflation to become a risk. Globally, markets remain fragile and any major shocks could cause volatility.

“This volatility should create opportunities for nimble, experienced investors with a proven ability to look through short-term noise and indentify long-term winners.”


Policy responses to remain a key driver of markets

Growing economic divergences highlight critical global imbalances that require intervention. The Eurozone is in crisis, China is tightening policy and the actions of developed markets threaten to spark currency wars. These issues all demand that policymakers adopt appropriate measures in a timely manner, yet policy response remains the single most difficult risk to assess. We believe that the ride will be bumpy but that policymakers will eventually arrive at the right place, allowing supportive fundamentals and ample liquidity to support asset prices.

  • The European Central Bank must act urgently, as it has been reactive and fallen behind the curve in protecting the Eurozone. The ECB should recognise that policy must support the weaker economies and not simply be tuned to the mantra of “one size fits all”. This will necessitate a policy that is far too easy for stronger members, but the viability of the monetary union is at stake. We believe the ECB is likely to adopt some combination of lower rates, below-market rate loans to troubled economies, liquidity provisions and outright bond purchases.
  • As QE becomes a more prevalent policy tool it is certain to evoke fears of competitive currency devaluation. There will likely be growing calls for capital controls in many developing economies reluctant to see an unwanted surge of liquidity into their economies. Such steps should not undermine the global growth story, but will likely stoke higher volatility across markets.
  • China’s deflationary boom is turning inflationary, representing a paradigm shift in the economy at the heart of global imbalances. The ability of Chinese policymakers to tighten policy without rattling investors will require more skill than in past cycles.
  • Ongoing de-leveraging continues to unleash powerful deflationary forces, which should allow developed economies to sustain modest growth whilst pursuing reflationary policies.

QE consequences

Quantitative easing has unleashed a wave of liquidity that must find a home. At the same time, it has stirred strong opposition in some quarters.

  • QE2 is explicitly targeting asset prices and liquidity is likely to find its way into the areas offering the best value and potential returns. Currently this means higher risk assets such as equities. This is one of the reasons why we remain overweight in equities versus bonds.
  • Specifically, emerging market equities and bonds are likely to be well supported. We may be in the early stages of a bubble in these assets.
  • Subsequent waves of QE will become increasingly difficult to defend on the world stage. This could tip the current phase of currency devaluation into full-blown protectionism. Stocks with significant overseas earnings could suffer in this scenario (this is not our central case).

“Emerging market exposure is a consensus trade, but it can continue to reap rewards throughout 2011. It doesn’t make sense to stand in the way of this tide of liquidity.” Sarah Arkle, Chief Investment Officer (Vice Chairman from Jan 2011)

Stock picks: Sun Hung Kai, Barrick Gold

Untested policies

The credit crisis elicited a range of innovative and untested policy responses. This is likely to lead to ongoing volatility, rotation and unforeseen consequences.

  • An important skill in 2011 will be the ability to look through short-term volatility to see the longer-term pricing anomalies.
  • Ongoing uncertainty means that it will be more important than ever to be aware of risks in portfolios and ensure that all risks are understood and intended.
  • Active management and stock picking are likely to add significant value in 2011.

“We are in completely uncharted waters here. Investors expecting a reversion to mean may be disappointed.” Jim Cielinski, Head of Fixed Income

The haves and the have-nots

Two-speed economies are developing at a global (emerging vs developed world), European (core vs periphery) and US level (skilled vs unskilled workforce). These distortions create socio-political tensions but also provide opportunities in a number of sectors.

  • US unemployment remains high but in certain sectors, wage bargaining power is evident. When analysing companies, we will be emphasising their ability to retain talented staff without instigating wage inflation.
  • With interest rates at all-time lows and QE2 targeting higher asset prices, employed, asset-rich consumers with mortgages should feel wealthier in 2011. This will support high-end consumer discretionary stocks.
  • European banks with exposure to the periphery have been de-rated significantly. This creates the scope for a sharp rally if solvency fears are addressed decisively by the ECB. We remain underweight but continue to monitor the sector closely.

“You can’t take someone that was laying bricks on a building site in 2007 and put them into Google’s product development team. Specialist skills are in short supply and will be rewarded in 2011.” Cormac Weldon, Head of US Equities

Stock picks: Tiffany, Polo Ralph Lauren

The search for yield

We believe that inflation is not a risk in the developed world and that interest rates will be kept at historic lows in these markets. As such, government bond yields are unlikely to rise significantly and investors will seek income in higher-yielding areas.

  • Emerging market and corporate bond valuations remain attractive relative to their improving fundamentals. We continue to favour these bonds over government issues in fixed income.
  • Income stocks are likely to be in favour in equities. Moreover, companies that are reinstating or raising their dividends are likely to be re-rated.

“Why would I lend money to the UK government at 3.5% when I can get 5.1% with the prospect of dividend and capital growth from AstraZeneca?” Leigh Harrison, Head of Equities

Stock picks: AstraZeneca, Vodafone, BT

The emerging market consumer

Emerging markets will continue to produce superior growth in 2011 and growing wealth among consumers in these markets will support demand in a number of areas.

  • We continue to invest in luxury goods stocks in Europe, where robust earnings growth has seen multiples decline despite rising share prices.
  • More recently, we have expanded this theme into European premium auto stocks, eg BMW, where the valuation is attractive relative to its Asian joint venture partners.
  • Banks in under-penetrated markets such as Indonesia and India are likely to attract capital as investors follow through the consumer theme.

“Luxury goods stocks were the first beneficiaries of growing emerging market wealth. The developing consumer credit cycle will create bigger ticket opportunities as this theme matures.” William Davies, Head of European Equities

Stock picks: BMW, Bank Rakyat

The return of capex

Companies have been very cautious in their investment plans in this cycle, preferring to maintain high levels of cash. Corporate balance sheets are strengthening and capital expenditure to depreciation ratios are at all time lows. We believe this trend will change in 2011.

  • Improving economic confidence and high commodity prices are likely to drive increased capex in the extractive industries. Industrial stocks will be among the key beneficiaries.
  • The replacement of ageing IT infrastructure at a wide range of companies will support earnings in the software and hardware sub-sectors.

“Mining equipment companies have been buffeted by changes in economic sentiment in 2010. They are attractively valued and there is scope for significant upgrades to earnings.” Simon Brazier, Co-Head of UK Equities

Stock picks: IMI, Komatsu

Mergers and acquisitions

Cash balances are high, valuations are attractive and companies will crystallise value in the market by undertaking earnings-enhancing corporate activity such as m&a. Meanwhile, private equity companies are under pressure to invest. Emerging market corporates are also likely to take advantage of currency strength to acquire footholds in companies in the developed world. This, together with share buy-backs, will drive a significant phase of m&a.

  • Companies with unique assets, superior growth or access to proprietary technology will be among the main takeover targets.
  • Management quality and valuation may not always be key drivers: small and mid-caps are likely to attract interest despite full relative valuations.
  • Companies deploying cash in shareholder-friendly ways are likely to outperform as investors become more focused on the efficient use of capital.

“2011 could be the year when a household western name gets taken over by an emerging market rival.” Jeremy Podger, Head of Global Equities

Stock picks: Mid-cap resources, industrial companies

Commodity prices will remain underpinned

The outlook for commodity prices is positive, given the recovery in the world economy and the dominance of resource-hungry emerging markets in the global growth profile.

  • Commodity-rich nations will continue to witness capital inflows, further strengthening FX positions and credit worthiness. This should support equity valuations and further spread tightening in fixed income.
  • Companies using more expensive raw materials in their production processes will witness margin pressures.
  • Rising commodity prices could be a source of inflationary pressure.

“Our growth forecasts imply additional demand of around 1.5m to 2m barrels of oil per day in 2011. If it becomes apparent that OPEC does not have sufficient spare capacity to meet this demand, the oil price could move sharply higher.” David Donora, Head of Commodities

  • Mark Burgess becomes Chief Investment Officer from Jan 2011, when current CIO Sarah Arkle moves into her role as Vice Chairman.


Issued by Threadneedle Asset Management Limited. Registered in England and Wales, No. 573204, 60 St Mary Axe, London EC3A 8JQ. Authorised and regulated in the UK by the Financial Services Authority. Threadneedle is a brand name, and both the Threadneedle name and logo are trademarks or registered trademarks of the Threadneedle group of companies. The research and analysis included in this document has been produced by Threadneedle for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice.

This material is for information only and does not constitute an offer or solicitation of an order to buy or sell any securities or other financial instruments, or to provide investment advice or services.

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