Not fixed, but feeling a lot better

Jeremy Gardiner, director at Investec Asset Management, looks back on a turbulent eighteen months and sets out what we can expect from 2010

What a difference a year makes. This time last year, there was nothing festive about the festive season. Markets had collapsed and looked like they wanted to fall further, economic news was deteriorating fast and analysts were rapidly downgrading their forecasts to keep up with collapsing consumers, companies and possibly even countries. There was a hole in the road and nobody knew how deep it was, nor what was in it. Rumours abounded that credit cards were equally toxic – the next subprime.

And in case anyone believes the reaction by asset prices to the crisis was overdone given the speed of the recovery, it wasn’t. The world came very close to a global financial collapse. This was not a bump in the road; this was a massive hole. Were it not for the enormous synchronised efforts of the world’s governments and central bankers, the whole system probably would have collapsed, which explains why they get so annoyed at some of these recently resuscitated banks, which were granted a stay of execution (and some of which are still on life support), paying out massive bonuses to the very same individuals who were responsible for the crisis in the first place. The banks however argue that if they don’t pay market-related bonuses, they will lose all their good staff, leaving behind – instead of a once proud British financial institution – a rotting carcass with a parastatal smell.

As this year’s festive season gathers momentum, the picture is entirely different. The stock market storm is long passed and the economic storm is gradually working its way through the system, with some regions recovering faster than others. Stock markets have been the big surprise for 2009. Everybody knew in March that they were oversold, but there also seemed no good reason for them to rise in any hurry. Very few bought at the bottom, and don’t kick yourself or your adviser if you didn’t. The world seriously looked as though it may collapse and anyway, consensus in the market was that this was a ‘dead cat bounce’. The expectation was that markets would rise 10% to 15% then collapse again, and that this was likely to happen a few times before there was any sustainable recovery. In other words, there was no reason to chase the market.

So the world waited in cash, because ‘cash was king’. Worldwide asset prices were blowing off steam and those with cash were set to be the winners. Fortunately or unfortunately when markets moved, they moved fast, with most investors missing most of the massive recovery rally.

So where are we now?

The world is in a fundamentally different place. Economic data is surprising on the upside and analysts are upgrading their forecasts to adjust for a faster than expected consumer and corporate recovery. However, if Dubai has taught us one thing, it is to reinforce the point that although healing, the world is not fixed. There is currently much debate surrounding how many consumers, companies and even countries are fundamentally unhealthy from a debt perspective and are surviving purely due to interest rates globally at record low levels. What will happen to them when interest rates inevitably start rising? Will they cope, or will some fall over? And if so, what are the ramifications? Who is exposed and by how much? And how much more can they take?

What can we expect from 2010?

We recently hosted an investment conference in Cape Town with a selection of SA’s top portfolio managers as speakers and panellists in various debates. There were several common messages and predictions coming out of that event, which roughly position what we can expect from 2010. Most believed that:

· Central banks have done what is needed to fix the world and should succeed.

· Their efforts, coupled with various disinflationary forces, will result in mild inflation going forward. (CPI inflation in SA should reach a low of around 4.5% by June and then remain within the target band for the rest of 2010.)

· US Dollar depreciation has run its course.

· Moderate inflation, an oversold US$ and a recovering world should theoretically slow gold’s rise, however it is a good hedge against something going wrong and it is the only ‘currency’ that central banks can’t print.

· Although emerging markets are going to see better growth than the developed world, they have run very hard on a relative basis and better value may be found in global equities, which have suffered ten years’ worth of poor performance. In particular global multinationals with exposure to emerging markets will benefit.

· Poor cash has gone from being ‘king’ to ‘trash’, as central banks are likely to keep rates lower for longer.

· While current rand strength was seen as unsustainable, investors were warned not to expect too much weakness either.

· In the fixed interest space, the sweet spot is in corporate bonds.

· Although the stimulus has increased the risk of bubbles, this stimulus probably won’t be withdrawn in a hurry, so therefore risk assets can probably be enjoyed for some time to come.

In summary then, for 2010:

· Benign inflation coupled with interest rates staying lower for longer and reasonable growth will be good for asset prices.

· Asset prices are neither expensive nor cheap, so significant asset price growth going forward is therefore not expected. However, equity returns should be positive and certainly better than cash. Therefore, equities remain the place to be, but more through lack of choice than anything else.

· One of the biggest risks to this picture is, ironically, a ‘V’ shaped recovery, as this will lead to interest rates rising prematurely and rapidly, putting a further burden on an over-indebted world.

· There may be an interim correction, however waiting for the correction has risks. Have a strategy and stick to it. Leave market timing up to the professionals.

We wrote this time last year that the global financial system had suffered a heart attack, that the patient had been resuscitated and the correct medication administered, but that it would take time to recover. We said that the patient would have to walk for a few years rather than run, and that there would be periods of nausea along the way. We have seen the medicine take effect this year, and the patient is feeling better, wanting to run. While another heart attack is highly unlikely, further running will mean the patient will feel faint and have to sit for a while to recover. There will be further bouts of nausea, but nothing like what you went through this time last year.

· Central banks have done what is needed to fix the world and should succeed.

· Their efforts, coupled with various disinflationary forces, will result in mild inflation going forward. (CPI inflation in SA should reach a low of around 4.5% by June and then remain within the target band for the rest of 2010.)

· US Dollar depreciation has run its course.

· Moderate inflation, an oversold US$ and a recovering world should theoretically slow gold’s rise, however it is a good hedge against something going wrong and it is the only ‘currency’ that central banks can’t print.

· Although emerging markets are going to see better growth than the developed world, they have run very hard on a relative basis and better value may be found in global equities, which have suffered ten years’ worth of poor performance. In particular global multinationals with exposure to emerging markets will benefit.

· Poor cash has gone from being ‘king’ to ‘trash’, as central banks are likely to keep rates lower for longer.

· While current rand strength was seen as unsustainable, investors were warned not to expect too much weakness either.

· In the fixed interest space, the sweet spot is in corporate bonds.

· Although the stimulus has increased the risk of bubbles, this stimulus probably won’t be withdrawn in a hurry, so therefore risk assets can probably be enjoyed for some time to come.

In summary then, for 2010:

· Benign inflation coupled with interest rates staying lower for longer and reasonable growth will be good for asset prices.

· Asset prices are neither expensive nor cheap, so significant asset price growth going forward is therefore not expected. However, equity returns should be positive and certainly better than cash. Therefore, equities remain the place to be, but more through lack of choice than anything else.

· One of the biggest risks to this picture is, ironically, a ‘V’ shaped recovery, as this will lead to interest rates rising prematurely and rapidly, putting a further burden on an over-indebted world.

· There may be an interim correction, however waiting for the correction has risks. Have a strategy and stick to it. Leave market timing up to the professionals.

We wrote this time last year that the global financial system had suffered a heart attack, that the patient had been resuscitated and the correct medication administered, but that it would take time to recover. We said that the patient would have to walk for a few years rather than run, and that there would be periods of nausea along the way. We have seen the medicine take effect this year, and the patient is feeling better, wanting to run. While another heart attack is highly unlikely, further running will mean the patient will feel faint and have to sit for a while to recover. There will be further bouts of nausea, but nothing like what you went through this time last year.

What can we expect from 2010?

We recently hosted an investment conference in Cape Town with a selection of SA’s top portfolio managers as speakers and panellists in various debates. There were several common messages and predictions coming out of that event, which roughly position what we can expect from 2010. Most believed that:

· Central banks have done what is needed to fix the world and should succeed.

· Their efforts, coupled with various disinflationary forces, will result in mild inflation going forward. (CPI inflation in SA should reach a low of around 4.5% by June and then remain within the target band for the rest of 2010.)

· US Dollar depreciation has run its course.

· Moderate inflation, an oversold US$ and a recovering world should theoretically slow gold’s rise, however it is a good hedge against something going wrong and it is the only ‘currency’ that central banks can’t print.

· Although emerging markets are going to see better growth than the developed world, they have run very hard on a relative basis and better value may be found in global equities, which have suffered ten years’ worth of poor performance. In particular global multinationals with exposure to emerging markets will benefit.

· Poor cash has gone from being ‘king’ to ‘trash’, as central banks are likely to keep rates lower for longer.

· While current rand strength was seen as unsustainable, investors were warned not to expect too much weakness either.

· In the fixed interest space, the sweet spot is in corporate bonds.

· Although the stimulus has increased the risk of bubbles, this stimulus probably won’t be withdrawn in a hurry, so therefore risk assets can probably be enjoyed for some time to come.

In summary then, for 2010:

· Benign inflation coupled with interest rates staying lower for longer and reasonable growth will be good for asset prices.

· Asset prices are neither expensive nor cheap, so significant asset price growth going forward is therefore not expected. However, equity returns should be positive and certainly better than cash. Therefore, equities remain the place to be, but more through lack of choice than anything else.

· One of the biggest risks to this picture is, ironically, a ‘V’ shaped recovery, as this will lead to interest rates rising prematurely and rapidly, putting a further burden on an over-indebted world.

· There may be an interim correction, however waiting for the correction has risks. Have a strategy and stick to it. Leave market timing up to the professionals.

We wrote this time last year that the global financial system had suffered a heart attack, that the patient had been resuscitated and the correct medication administered, but that it would take time to recover. We said that the patient would have to walk for a few years rather than run, and that there would be periods of nausea along the way. We have seen the medicine take effect this year, and the patient is feeling better, wanting to run. While another heart attack is highly unlikely, further running will mean the patient will feel faint and have to sit for a while to recover. There will be further bouts of nausea, but nothing like what you went through this time last year.

· Central banks have done what is needed to fix the world and should succeed.

· Their efforts, coupled with various disinflationary forces, will result in mild inflation going forward. (CPI inflation in SA should reach a low of around 4.5% by June and then remain within the target band for the rest of 2010.)

· US Dollar depreciation has run its course.

· Moderate inflation, an oversold US$ and a recovering world should theoretically slow gold’s rise, however it is a good hedge against something going wrong and it is the only ‘currency’ that central banks can’t print.

· Although emerging markets are going to see better growth than the developed world, they have run very hard on a relative basis and better value may be found in global equities, which have suffered ten years’ worth of poor performance. In particular global multinationals with exposure to emerging markets will benefit.

· Poor cash has gone from being ‘king’ to ‘trash’, as central banks are likely to keep rates lower for longer.

· While current rand strength was seen as unsustainable, investors were warned not to expect too much weakness either.

· In the fixed interest space, the sweet spot is in corporate bonds.

· Although the stimulus has increased the risk of bubbles, this stimulus probably won’t be withdrawn in a hurry, so therefore risk assets can probably be enjoyed for some time to come.

In summary then, for 2010:

· Benign inflation coupled with interest rates staying lower for longer and reasonable growth will be good for asset prices.

· Asset prices are neither expensive nor cheap, so significant asset price growth going forward is therefore not expected. However, equity returns should be positive and certainly better than cash. Therefore, equities remain the place to be, but more through lack of choice than anything else.

· One of the biggest risks to this picture is, ironically, a ‘V’ shaped recovery, as this will lead to interest rates rising prematurely and rapidly, putting a further burden on an over-indebted world.

· There may be an interim correction, however waiting for the correction has risks. Have a strategy and stick to it. Leave market timing up to the professionals.

We wrote this time last year that the global financial system had suffered a heart attack, that the patient had been resuscitated and the correct medication administered, but that it would take time to recover. We said that the patient would have to walk for a few years rather than run, and that there would be periods of nausea along the way. We have seen the medicine take effect this year, and the patient is feeling better, wanting to run. While another heart attack is highly unlikely, further running will mean the patient will feel faint and have to sit for a while to recover. There will be further bouts of nausea, but nothing like what you went through this time last year.