It’s still best to play safe with markets

Jul 8 2009 Andrew Miller, regional office head of Barclays Wealth

AFTER a dire start, 2009 has seen a strong recovery in “risky” asset markets – reflecting the fact that investors are no longer worried about a “Great Depression”.

However, while leading indicators of macroeconomic activity have undeniably shown improvement, there is still a small but significant risk that psychological forces could start to dominate investor behaviour again – thus rendering traditional macroeconomic policy responses ineffective.

As far as recent policy moves are concerned, the countries that have implemented the biggest policy shifts have enjoyed the fastest – and largest – turnarounds in their fortunes. So emerging markets are generally more advanced in the economic cycle than the so-called “advanced” economies. Indeed, if we compare measures of business confidence in Brazil, India and China (BIC) with those in the US, Europe and Japan, we see that the ‘BICs’ have all bounced back into growth-mode again, whereas the advanced economies are only gradually finding their feet.

Among the advanced economies, we thought that the US would suffer least, and lead the way in recovery, because of the sheer scale of the US policy response. That seems to have been the right conclusion to have drawn, and we still expect the US to lead the developed world towards recovery.

However, while the risk of a “Great Depression” has faded, the global economy is still far from being “out of the woods”. Oil prices have moved past our fair value of US$65/bbl and we have to ask ourselves if they could overshoot again. And, while policymakers have generally done a good job of rebuilding consumers’ confidence, the bottom line is that households in the US, UK and Europe will have to save a larger fraction of their incomes in the future, rather than relying on (unsustainable) capital gains on their houses as a substitute.

Looking forward, we suspect the oil price will only edge higher, given still weak global demand, Opec’s limited ability to curtail production, and high oil stocks.

We therefore doubt that overall consumer price inflation will soar again. In any case, spare productive capacity, and the fact that firms are making their remaining employees work much harder, should help to keep inflation contained.

Overall, we expect the shape of consumer spending – and hence the profile for global GDP – to be governed by real wage growth, fiscal handouts and employment prospects. Taking these together, the broad trends are supportive of a weak recovery.

Meanwhile, the stock market rally means that individuals should stop worrying. As a result of all this, we think that consumer spending will start growing again in the advanced economies, but not dramatically. However, investment is likely to fall further across the advanced economies, and only hit a bottom towards year-end.

All in all, the global macro environment is likely to be much more benign than the one we suffered at the end of last year. However, that doesn’t mean that markets are poised for a further rally. Indeed, we suspect that riskier asset classes will trade sideways for a while, as investors contemplate what’s next: a sluggish recovery; a recovery with some real impetus; or, worst of all, a slide back towards the abyss.

Of these three scenarios, we put the probability of the first at about 60%. Of the other two, we judge them to be equally likely, at about 20% each. In the interim, it is unlikely that risk assets will make much headway, so investors’ portfolios should be tilted back towards their strategic norms.

Andrew Miller is Newcastle regional office head of Barclays Wealth