Comment: Flexibility is required in the face of recovery risks for 2010
Alan Brown, Chief Investment Officer (pictured) and Keith Wade, Chief Economist, Schroders, share their views on the potential factors that could derail the global economic recovery and argue the case for greater portfolio diversification.
We predict that the current global rally is likely to continue into 2010 with emerging markets leading the economic recovery, whilst the sweet spots of low interest rates and rising profits should continue to drive assets through 2010. However, there are a number of potential monetary and economic factors that could de-rail the recovery. Schroders therefore recommends a more dynamic approach to asset management involving greater diversification and flexibility in order to protect clients’ portfolios.
Schroders has revised up its economic forecasts for global growth to 2.7% in 2010 and believes that corporates are going to be important to maintain this recovery - corporate profits are likely to outpace GDP as a result of improved profit margins. Equally, inflation pressures are expected to remain subdued and emerging economies, which now account for more than half global growth, will continue to drive the global recovery.
Nevertheless, there are also a number of headwinds that could slow the recovery. They include weak bank lending, quick exit strategies from quantitative easing, the risk of inflation, particularly in emerging markets, as well as a double dip in the economy if the boost from cost cutting fades and the pressure from the credit crunch continues. On the other hand, there is a risk of bubbles forming in emerging markets where there is a mismatch between the gathering pace of economic activity and monetary policy. This, in turn, is tied to the US through the dollar.
Schroders believes that a more dynamic approach to asset management will be the key to surviving the coming years. This involves adopting diversified and flexible strategies for asset allocation in recognition of the wide range of possible outcomes, for example deflation/inflation and P/E multiple expansion and contraction. Schroders is currently overweight equities, credit and gold and significantly underweight cash.
The easy money has been made and we are now faced with a range of possible outcomes for coming years that are so wide that asset managers should adopt a more dynamic approach to asset allocation. This should be based on real world outcome based strategies rather than the relative return focus, which has been so prevalent over the last 20-30 years. This is a time for putting a premium on diversification and maintaining the flexibility to respond as developments unfold.
It is going to be a bumpy ride but we believe that economic growth can be maintained because the growth in emerging markets and recovery in corporate profits reduces the chance of a double dip, governments are likely to be cautious with their exit strategies and for the time being deflation is actually more of a risk than inflation, with the exception of the emerging markets. The long-term challenge is to rebalance the world economy.
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