A bumpy road to recovery

Mar 19 2010 by Karen Wilson, The Journal

THE latest GDP data revealed that the UK economy was out of recession, but still lagging the likes of the US. While the global economy as a whole also appears to be growing again, the path ahead won’t be smooth. Like the winter snow, although recession has passed, the extreme conditions have left potholes in the road to recovery.

The tentative UK and global recoveries have so far been driven by production – as opposed to the typical consumer-led rebound – and supported by unprecedented government and central bank stimulus.

Recovery should continue in 2010, supported by inventory rebuilding, a revival in world trade and the commitment of policy-makers to continue providing stimulus until growth becomes self-sustaining.

While the outlook is generally positive, consumers and governments across the developed world are weighed down by a mountain of debt.

Meanwhile, financial institutions will be restricted in their ability to lend as they continue to work off the excesses of the credit boom that went bust. This is likely to make for a bumpy ride in 2010, with more of a saw-toothed growth path than a “V-shaped” return to the boom years.

Recent US data suggest the world’s largest economy has made the transition from late recession to recovery. Yet the level of economic activity remains well below pre-crisis levels. This contrasts strongly with China, where many indicators have surpassed their previous peaks.

A look at past recoveries after a long-term bear market shows that there are often ‘wobbles’ when investors start to anticipate rate rises in the US. This time Chinese monetary tightening has triggered some wobbles, highlighting the shift in the balance of power in the global economy from the US to China.

Greece’s fiscal problems have added to the recent souring of investor sentiment, and with 200 years of history showing that sovereign debt crises tend to follow banking crises, it looks as if history may repeat itself.

THE INVESTMENT OUTLOOK:

In the second half of a recession, riskier assets such as equities and corporate bonds typically perform very strongly and valuations rise in anticipation of recovery. This was clearly the case from March last year through the start of 2010.

Yet once recovery takes hold, equity returns tend to be much lower than in the final stages of the recession, as investors have already anticipated and “priced-in” rising profits. Nevertheless equities tend to outperform government bonds, whose prices move inversely to rising yields. This is what we expect to happen over the course of 2010.

We expect bond yields to be pushed higher in 2010 by not only the normal cyclical pressures, but also concerns about very heavy government debt loads.

If politicians do not come up with more credible plans to restore public finances, markets will force them to through some combination of higher bond yields and weaker currencies, as they did with Greece.

The Chinese, via rapid lending growth and very aggressive fiscal stimulus, have almost single-handedly kept the global economy afloat over the past year. Chinese tightening is a significant development with potential to upset markets.

While we anticipate further gains for global equity markets this year, we also believe there are likely to be further corrections along the way. These corrections should prove to be buying opportunities, however, as it becomes clear that recovery is continuing.

Evaluating which mix of asset classes are the most appropriate, over which time horizon, are often key considerations for our clients, especially in this low interest rate environment.

Are your savings and investments really working as effectively as they can, given your attitude to risk?

At Coutts in Newcastle, the experienced team of private bankers have built up expertise in dealing with clients in such situations and are able to work closely with individuals and families to help them through what can be a challenging time.

For more information about becoming a Coutts client in the North East, contact David Simpson on 0191 203 7031; david.simpson@coutts.com or visit www.coutts.com