The first stage of government intervention in what is likely to be a long haul out of the post-Lehman crisis is drawing to a close. The challenge going forward will be to see if the eye-watering stimulus packages applied to world economies have real durability, or whether – as soon as policy makers start to reverse these programs – economies slip back, Japanese-style, into near-zero deflationary growth. These worries are driving investors into government bond markets, and condemning equities to a frustrating market trading range, regardless of the quality of earnings they produce. However, the Sarasin Group forecasts in its latest Strategy Outlook that this won’t last for very long – either economic growth stabilises at some point, bond yields normalise and stocks rally, or else central banks release more liquidity, yields fall further and ultimately investors buy blue-chip stocks for their balance sheet strength and yield. Sarasin’s response is be cautious on higher risk investments for a while longer, and to be patient, but also to sit back, and enjoy the unusually strong cash flow and dividend growth of cash-rich ‘Nifty Fifty’ stocks which remain at the heart of Sarasin’s equity and balanced portfolios. Guy Monson, Chairman of the Investment Policy Committee ”To date, where governments have ‘tested the waters’ and cut stimulus, the results have been decidedly mixed. It is this uncertainty among businessmen, economists and politicians alike that is driving investors into the arms of the government bond markets, and condemning even the very best of the ‘Nifty Fifty’ blue-chip equities into a frustrating market trading range, seemingly regardless of the quality of earnings or dividends they produce. Our hunch is that this won’t last for very long but investors will need to be patient – either economic growth stabilises at some point, bond yields normalise and stocks rally, or else central banks release more liquidity, yields fall further and ultimately investors buy blue-chip stocks for their balance sheet strength and yield. In the meanwhile, sit back and enjoy the unusually strong cash flow and dividend growth of the global ‘Nifty Fifty’ stocks.” Burkhard Varnholt, Chief Investment Officer ”With fiscal policy largely exhausted and politically difficult, policy makers have experimented by kicking away a few monetary crutches across the world economy, with decidedly mixed results. For example, the end of Switzerland’s expensive and ambitious forex interventions to hold down the Swiss franc has seen the currency back at its all-time highs against the euro. In Europe, at the height of the Greek crisis in May 2010, the European Central Bank (ECB) was forced to relent and take lower quality sovereign debt onto its balance sheet, breaking a commitment not to directly intervene in bond markets. By contrast, the expiry of central bank gilt purchases in the UK did not see bonds collapse as many, including ourselves, suspected they might; foreign central banks and institutions largely made up the difference.” With core inflation in the US at a near fifty-year low James Bullard, the St. Louis Federal Reserve Bank President, recently released an academic paper extolling the virtues of more unconventional money policy. He argued that in order to combat low and declining inflation expectations, the US Federal Reserve should use further aggressive purchases of Treasuries instead of committing to keeping interest rates low for an extended period of time. Right or not, investors can be sure that the debate will be about how best to deploy their limited arsenal and create new ammunition to give the economy sufficient escape velocity from the jaws of deflation. With a slower economy in the US and China and fiscal austerity at home, inflationary pressures in the euro area are unlikely to emerge, making the ECB exit strategy from its loose monetary policy unlikely before mid-2011. And, despite the success of the EU stress tests in restoring confidence in the European banks, the ECB will have to continue to provide them with ample liquidity, as the wholesale market (where European banks access short-term funding) remains closed. In Japan, too, Economics Minister Satoshi Arai states that the government needs to work with the Bank of Japan (BOJ) to respond to the sharp rise in the Japanese yen against the US dollar. He added that the government was in discussions with the BOJ on the yen rise, and he would be monitoring its potential prevention of a self-sustaining economic recovery – another global candidate for an imminent quantitative easing program. “Nifty Fifty” The 50 most favourite stocks by institutional investors. Companies in this group are characterized by consistent earnings growth and high P/E ratios. Examples include Roche, Cisco and Intel. The irony of this economic uncertainty corporate earnings remain extraordinarily robust – up 37% this quarter in the US, with a near record 75% of companies beating estimates – and similar trends can be observed across all major markets. Meanwhile, despite a mountain of negative sentiment, global growth seems to be just about holding steady; last month, the IMF upgraded activity for this year from 4.2 to 4.6%, which seems to be ample for cash-rich, extraordinarily lean global blue chips. Sarasin’s analysts are still seeing material opportunities in global companies almost regardless of the economic backdrop. Global Investment Strategy Implications Government yields found new lows following the Federal Reserve’s announcement that their balance sheet will be maintained by replacing maturing securities with 2- to 10-year US Treasuries. While still being reluctant to purchase mid- and longer-dated government bonds at these yields, because of the absence of convincing long-term value for clients, Sarasin has particularly focused on the prospect of currency appreciation in the local Asian markets. Sarasin also favours developed market issues from leading emerging world companies and retains an opportunistic and value-based approach to index-linked issues globally. Despite the ongoing inability of peripheral European banks to fund away from the ECB, the release of the CEBS stress tests has been broadly positive for the wider investment grade corporate debt market. There are pockets of value, despite the generally low yield environment and Sarasin’s credit, emerging markets and index-linked fixed interest teams are finding plenty of value opportunities, despite a cautious view of the extraordinary rally in long-dated government issues. Investors understandably remain perplexed by the countless macro risks they hear from central bankers and the financial press, in contrast to the consistent profitability reported by global blue-chips and the comparative confidence of their CEO’s. Sarasin recommends to be cautious on higher risk investments for a while longer, and to be patient, but also to sit back, and enjoy the unusually strong cash flow and dividend growth of cash-rich ‘Nifty Fifty’ equities that Sarasin continues to hold at the heart of its equity and balanced portfolios.
