Threadneedle: March economic and market update
Towards the end of 2012, we witnessed the negative impact that political battles can have on economic activity.
Concern over the outcome of the fiscal cliff negotiations in the US caused a freeze in corporate decision-taking and spending. We anticipated a bounce back once the outlook was clearer and recent meetings with US company management teams have confirmed that this is taking place.
We have also seen companies benefiting from capital expenditure, while general corporate suppliers have seen a useful acceleration in activity. Arguments over cuts to government expenditure, known as the ‘sequester’” remain, but the effect should be over a reasonable period of time and not too material. Meanwhile, the US housing market and employment data continue to strengthen.
In light of this encouraging backdrop, we have raised our forecast of US corporate earnings growth for 2013 to 9%. In contrast, we have cut our forecast for European corporate earnings for the current year to a fall of 5%. This reflects the very sluggish European economy and the impact of the recent rally in the euro on overseas earners and exporters.
The attempt to apply special taxes to depositors, as part of the Cypriot bailout, has important ramifications, both economic and political, sparking fears over contagion and depositor flight in other peripheral countries and boosting anti- EU sentiment within the eurozone.
In the UK, we have made no changes to economic or earnings forecasts. Company results have been fairly encouraging, share buybacks, which enhance earnings, are growing and sterling’s weakness helps underpin our forecast of high single-digit earnings growth for 2013.
Finally, China has recently imposed new controls on the housing market to supress inflation. Whilst this will restrict growth to some extent, we expect consumption to remain robust and are confident that growth should stabilise around current levels. We expect GDP to grow by a little under 8% this year.
While we see some recovery in the global economy, it continues to be a tough environment for companies to operate in and it is therefore crucial to pick the winners that can do well against this backdrop. We have identified a number of themes that we believe will help us to select the better performers.
We expect a relatively strong US economy, which should see significant benefits from likely energy independence. This favours dollar earners and US cyclical exposure in particular. We anticipate online retailing to grow further, at the expense of bricks and mortar, in a similar revolution to Walmart’s achievements in the 1990s relative to their traditional competition.
We believe that consumption in the developing economies will remain robust, benefiting consumer staple companies, retailers, banks and luxury goods companies. In Europe, our theme is to focus on strong exporters rather than domestic companies hit by the depressed economy. Finally, we expect the search for income to drive investors towards high yielders, particularly where dividends are well covered by cash flow.
Towards the end of 2012 and early 2013, many of last year’s equity laggards rallied in a period of rotation as risk appetite rose. More recently, we have seen greater discrimination in performance, favouring the better-placed companies and those able to show reasonable growth. This has been helpful for our equity portfolios.
Our asset allocation matrix, favouring equities over bonds, has served us well in recent months. Markets are clearly vulnerable to a correction but valuations continue to be pretty attractive, quantitative easing remains on the table, corporate results have been fairly pleasing and it appears that retail investors are adding to their exposure in shares. Consequently, we retain that position.
