Variables point to staying in 'risky' investments

Mar 10 2010 by Andrew Miller, The Journal

MARKETS look range-bound still. Global stocks, credit and commodities have rallied since February's swoon, but have yet to reach new highs; meanwhile, "safe haven" Treasury yields are up from their lows.

One widely-watched proxy for investor nervousness – the VIX, a measure of the cost of portfolio insurance – has again subsided to what we view as its long-term trend.

In terms of our broad view of markets, we continue to favour stocks and corporate credit ahead of Treasuries. We can’t pretend to see any near-term catalyst that will push the former decisively above, and the latter below, their recent trading ranges, but that doesn’t mean that we would recommend “sitting out” the rest of the first half of 2010.

Quite the opposite in fact: we believe that investors should stay invested. This is especially important given that we know from previous experience that such catalysts can be difficult to spot in advance, and are sometimes not even needed for markets to make their move.

However, while we retain a positive view on equities, this doesn’t mean that we are unaware of the downside risks. Investor nervousness over sovereign debt, or a “double dip” the US, has not gone away; and indirect monetary tightening (via moves to restrict bank lending) is starting to feature on the investment horizon.

It is already visible in three of the four so-called “BRICs” (Brazil, India and China, with Russia the only one not to move), and may soon start to register even in developed markets, although we still doubt that “official” interest rates will start to rise until near year-end.

So, for the time being, we would advise investors to protect their underlying portfolios against any short-term market losses, rather than to fundamentally restructure them. This is advice that we think is also relevant to the more specific risks facing UK assets ahead of the pending general election.

In essence, however, we see the recent rebound in risk aversion as modest in scale – as were last autumn’s – and note that throughout February, there were continuing outflows from US money market mutual funds (the safest of safe havens). We would also note that with some $3.1trillion still parked in such funds, that particular source of investable funds is still far from exhausted.

One of the reasons for staying invested in “risky” assets is that the objective variables that should matter most to investment – the fabled “fundamentals” – seem to us to be mostly pointing in the pro-risk direction.

Corporate profits are likely to grow by roughly 30% in 2010 – a gain which in our view is not priced in to equity values – and the economic recovery suggests that those gains may have a stronger revenue element than many had thought.

We are not unsettled by the still-patchy news on US consumer “confidence”. What consumers say they feel is much less important than what they do: the key issue is whether they continue to spend or not. The labour market will of course be the last thing to stabilise – as Friday’s US non-farm payrolls data reminded us again – but there are other things supporting consumer spending power, most notably the unprecedented rebound in household free cash flow, equivalent to a staggering 8% of GDP since mid-2007. Such firepower should help consumers – and thus equity markets – in the coming months.

:: Andrew Miller is regional office head of Barclays Wealth in Newcastle