Tough times ahead but we should avoid a recession

Jan 2 2008

Peter Stoney, Senior Fellow, Liverpool University Management School (158)

Business editor Bill Gleeson looks at what the New Year may have in store for business

CHIEF investment officer at Rathbone Unit Trust Management Julian Chillingworth draws on the football adage by saying next year will be a year of two distinct halves.

He said: “With markets down in the first half, investors will worry about slower growth in G7 economies; higher inflation; and slower earnings growth. As economies slow, we anticipate opportunities provided by interest rate cuts that should spark a second half recovery.

“We expect the FTSE-100 to end 2008 on 6400.”

Globally, Mr Chillingworth expects some of the world’s bigger emerging economies to do well. Brazil, Russia, India and China’s economies have demonstrated exceptional resilience, and we expect more of the same in 2008. We are unconvinced that they have entirely decoupled from the West. The test will no doubt be the effect of a weaker US economy, particularly with respect to China and its exports.

“My guess is that a judder could find investors running for the exit as eagerly as they entered. The Middle East is a slightly easier call. We expect sovereign wealth funds – in no small way a Middle Eastern phenomenon – to have a greater impact on markets in 2008 as the drive to secure resources intensifies and interest in ‘bargain’ territory, such as financials, grows.

“We anticipate a significant housing-led slowdown in the US in 2008, but not a recession, certainly not yet. A weak dollar is not necessarily a bad thing: it helps to reduce the US’s burgeoning current account deficit. However, changes potentially afoot in exchange rate regimes, coupled with any further dollar weakness, could trigger more disorder and drive investors to seek new stores of value, such as gold. The US consumer seems to be holding up for now; but we expect there to be more pain as billions of dollars worth of mortgage rates are reset next year. The overall suggestion from markets is that, despite uncertainty about the US, the world economy will be able to avoid a recession.

“Japan is another region where export growth is under threat. A slower US could hurt Japanese exports.”

So what does this all mean for UK investors?

Market volatility has led to a long-awaited re-pricing of risk in equities. Valuations are cheap by historical standards, and we expect earnings to deliver growth in 2008, albeit in low single digits.

“Consequently, it seems right to retain overweight equities versus other asset classes, including bonds. Whilst inflation jitters are stoked, inflation-linked bonds have the potential to outperform conventional bonds although corporate bonds remain vulnerable to pressures in the credit markets.

“We are in no rush to enter the market, and prefer to drip-feed money back in, as and where appropriate. In short, this means investing in those companies with strong competitive positions, obvious strategic value, and strong balance sheets with low levels of leverage.

“In our portfolios, we are maintaining a defensive edge but are also beginning to see value emerging at the smaller end of the market. A strong theme across all of our portfolios continues to be well -supported areas of the global economy, fuelled by emerging market demand, such as energy and power generation.

“Aerospace, big oils, food retailers, and infrastructure sectors should remain underpinned by strong fundamentals into 2008.

However, we expect financials and housing-related stocks to remain volatile while uncertainty reigns.