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08-01-2010
2010: A year of transition
Whereas the first quarter of 2009 was completely overshadowed by the global financial turmoil as economies contracted and equity markets plunged, since the third quarter the
economic rebound has been the focus of attention. Already at the beginning of the year Bank Vontobel assumed that the massive monetary and fiscal stimulus measures would take
effect in the second half of the year, bringing stability to the global economy. Accordingly, the Bank systematically increased its equity allocation from the second quarter
onward.
This year, 2010, may well prove to be a year of transition. From the second half of the year central banks around the world will cautiously move to normalize monetary policy by
making the first increases in the new interest rate cycle, which in turn will put upward pressure on government bond yields. The public finances of states in the western world
will further deteriorate this year. In 2010 the rally in equity markets will increasingly be driven by earnings rather than the realization that efforts to stabilize the financial
system are proving successful. As a result, stocks will continue to advance, but not as robustly as in 2009.
Equity markets 2009: Crushed by despair, shouting in triumph
The stock market collapse that began in 2008 continued its dramatic descent until mid-March. All sectors without exception suffered huge losses. By mid-March it was clear that the
extraordinary monetary and fiscal steps taken by governments worldwide in 2008-2009 would remove the danger of systemic failure, and the markets turned. For equity markets the
rest of 2009 turned out to be not only as good as expected, but very good. The rapid recovery in stock markets since mid-March must be seen in the context of the dramatic collapse
in the preceding period. Given the uncertain outlook for the global financial system, in an initial, and understandable, reaction equity markets collapsed almost overnight. In the
process, prices in financial markets fell to levels comparable with those of the Great Depression. The subsequent powerful rebound in equities reflects the corresponding
countermovement once it was clear that no other banks "too big to fail" would be allowed to collapse. In addition, the improvement in stock markets reflected the
expectation that at some point economic growth would resume. Hence, much of the rally was driven not so much by expectations of gains as by relief that a repetition of the Great
Depression had been averted.
Although we reduced our equity allocation at the beginning of the year, we continued to work on the assumption that the enormous monetary and fiscal packages would take effect in
the second half of the year, the economy would stabilize, and stock markets would reflect these developments six months in advance. As a logical consequence of this view, we moved
back into equities at the beginning of April and raised our equity allocation again in summer in anticipation of an economic recovery in 2010.
The star performers among equity markets in 2009 were the emerging markets of Asia, Eastern Europe, and Latin America. In the developed countries, the outperformers by industry
were cyclical sectors such as commodities, technology, and consumer discretionaries. Our recommended investment themes, including "future and renewable resources," real
estate stocks, and commodities, proved to be rewarding investments.
Outlook: 2010: The year of transition
Our core scenario forecasts that in 2010 and 2011 the global economy will expand again, but at a below-average rate. The basis of any global recovery is expansionary monetary and
fiscal policies around the world. As is well known, the major impact of the US fiscal stimulus package will be felt only in 2010. Correspondingly, US public debt is set to rise
sharply in 2010. However, as long as investors' appetite for risk remains moderate, they will continue to demand only a modest premium to buy government bonds. As a result,
government bond yields should increase only marginally.
Inflationary pressures remain muted owing to the low utilization of productive capacity and the extreme cautiousness of the financial sector in extending credit. In the final
analysis, this scenario is positive for financial markets, resulting in only slightly firmer yields in the capital markets, a somewhat weaker Swiss franc, and moderate advances in
equity prices. Although other economic scenarios are also conceivable, the likelihood of their occurring is relatively low. Whereas a positive scenario assumes a rapid, V-shaped
economic recovery, the negative scenario foresees the second arm of a double-dip recession in 2011. In this scenario the negative effects would be noticeable in the financial
markets from the coming spring. This situation could arise particularly if the central banks were to raise interest rates too quickly or if the global economy failed to transition
successfully from artificial respiration to self-sustaining global growth.
We have drawn up the following three investment themes on the assumption that our core scenario proves to be correct.
1) Equities remain attractive; transition to defensive sectors in the course of the year
Even after a solid performance in 2009, global equity markets are not expensive and continue, therefore, to offer good opportunities for attractive returns. That said, equities
will no longer be driven primarily by the "principle of hope," but increasingly by earnings growth. Against the backdrop of the collapse in earnings in 2009, 20%
earnings growth, as currently factored in by the markets, should be within easy reach. We therefore expect that earnings contraction to give way to earnings growth. Although this
signals further advances in the equity markets in 2010, the returns will be lower than in 2009. In addition, in the course of the year investor attention will increasingly shift
to more defensive, value-focused sectors that lagged in 2009. Topics that will continue to attract market interest include the emerging countries, renewable and future resources,
and infrastructure.
2) Yields on government bonds gradually rise; preference for corporate bonds
Although inflation will not be a cause of concern in 2010, in the second half of the year central banks will still move cautiously to gradually normalize monetary policy, which
will exert gentle upward pressure on interest rates over the entire yield curve. The threat of ballooning government debt and defaults is also likely to drive up interest rates.
Despite an outstanding performance in 2009, corporate bonds remain attractive on account of more favorable yields; where possible they should be given preference over government
bonds.
3) Commodities cycle not over; commodities remain in focus
Since 2002, commodities have been enjoying a strong secular rally, which, however, is starting to exhibit signs of maturity. In view of the enormous needs of emerging countries as
they try to catch up, this rally probably has some distance to run yet. This holds for all three core segments of the commodities sector: energy, industrial and precious metals,
and agricultural goods. If, as anticipated, prices of conventional fuels and resources rise, demand for alternative energy sources will increase. This is what makes the investment
theme of renewable and future resources so attractive.
We see the following as the three major risks for investors in 2010:
- A correction in equity and corporate bond markets gets underway early in the year on the back of fears of renewed recession in 2011.
- The problem of government debt escalates and yields on government bonds rise more quickly and sharply than expected.
- The risk of deflation, and thus of a "Japanese situation," increases. Despite the enormous amount of liquidity created by the central banks, it is not passed on
to the real economy.
2010 will probably go down in history as a year of transition. Transitions always go hand in hand with uncertainty. Despite huge challenges, there is a realistic chance that the
transition will be successful. One important task will be to reconcile necessary regulatory guidelines for the economy with the need to preserve the benefits of a free-market
economy. We should not forget that the roots of the current crisis can be traced back to intervention in the market, namely the decision in the early 1990s to subsidize mortgages
for US home-buyers.
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Dr. Thomas Steinemann
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| Chief Strategist of the Vontobel Group |
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| +41 (0)58 283 78 44 |
| E-Mail |
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