With valuations for global equity markets currently not compelling and giving little room for the potential earnings disappointments that could accompany the slowing of the global economic recovery, Percival Stanion, head of Asset Allocation at Baring Asset Management, explains why, with the remainder of 2011 likely to be volatile and uncertain, a tactical and well-timed approach to asset allocation is more important than ever…
After two years of strong growth, recent data suggests that most economic indicators are now peaking out in the West from the troughs of early 2009. Europe is a case in point in this regard and while the industrial recovery in the US is still strong, the consumer sector remains subdued and the housing market looks as if it could be due another downswing. Factor into this picture the fact that inflationary pressures are only just being brought under control in emerging markets and it is clear that short-term momentum looks weaker at the margin. Within this main cycle, there are several mini-cycles where we will want to vary our risk exposure.
Against this backdrop, the short-term outlook appears choppy. There is uncertainty surrounding the forthcoming end of quantitative easing in the US and there will probably be several months of doubt as we try to gauge whether the US economy is strong enough to absorb the effective tightening in liquidity conditions. Over in Europe, the sovereign debt crisis stubbornly rumbles on and the latest news from Greece is not encouraging. More worrying still is the likelihood that Spain will join Greece, Ireland and Portugal as its growth is also likely to disappoint. Although we do not foresee the collapse of the European single currency, a fundamental realignment is necessary with the possible expulsion of some weaker peripheral members.
One area that is seeing growth is emerging markets. This does however continue to be accompanied by rising inflationary pressures and it expects some economies to significantly tighten their policies to get inflation under control which will result in headwinds. Barings is currently focusing on large multi-national corporations with exposure to emerging market economic growth.
Looking at equity valuations, the risk premium currently on offer is around the ten-year average which is less compelling when we recognise that risk premiums have been rising over that period. Faced with this outlook, we think it is prudent to adopt a lower risk profile at present and hold for a more attractive entry point to risk assets. In the current environment we favour Australian and US government debt, which are currently good risk diversifiers.
A real asset we favour is UK commercial property. As banks unwind their exposure to such assets, we believe that investors with long-term investment horizons will be offered attractive opportunities, not just in property, but in other areas where banks had perhaps previously played too big a role in the funding process.
In looking for cheap entry points for risk assets we have shifted our cyclical mix within equities. We have upgraded consumer staples and healthcare and downgraded consumer durables and Telcos. We made no changes in terms of bonds, but for currencies, we downgraded the Canadian Dollar after a particularly strong run.
