Team adds to risk assets across the board - upgrades emerging market equities and local currency government debt
Barings' Global Multi-Asset Group has been adding to risk assets across the board, upgrading equities and downgrading government bonds and cash. Within equities, the team has upgraded cyclical areas such as emerging markets, as well as Energy, Financials and Industrials. These moves are balanced by some downgrades to more defensive areas such as Telecoms and Consumer Staples. In bonds, the team has upgraded emerging market local debt, while cutting Australian bonds.
Percival Stanion, Head of Asset Allocation at Barings says: "The recent changes to our portfolios are significant as this is the first time we have been ‘risk on' for more than a year. Despite this, we are not of the belief that we are heading into a new bull market. This is a tactical move that may last only a matter of months, but we expect to see a sharp upward move in markets over this timeframe. The compelling argument comes from the deep pessimism now pervading the market place, huge piles of cash and low yielding government bonds and bills in investor accounts, and the very cheap rating of equities, particularly in the US. "
"The economic situation does look quite poor. A European recession is well underway due to austerity measures in the south and we see no early end to this. The main policy response is likely to rest with the European Central Bank (ECB). Here, the change in collateral requirements on the latest long-term refinancing operation (LTRO) programme is of key significance. It removes a major element of the tail risk - i.e. a potential bank failure - from the immediate environment. It also means liquidity is likely to remain abundant and we will be watching the next LTRO allotment process in February with keen interest - another big figure in the region of €500bn would be hugely significant.
"Our best guess is that this is the manner in which Europe will manage its way through the crisis as the German electorate is just not ready for full fiscal union, or euro bonds, but might turn a blind eye to support delivered via ECB liquidity infusions. While none of this addresses the long-term issues of competitiveness facing the whole of southern Europe, such ECB action may appease markets over the short-term."
Outside of Europe, the US economy has remained resilient, where the underlying rate of growth is around 2.0-2.5% in GDP terms. The latest car sales figures show just how optimistic consumers are - and this without the benefit of discounts. Meanwhile, jobs are being created and hours worked and wage rates are slowly rising. The housing slump continues but at least it seems to have stabilised. Critically, the Federal Reserve has also signalled that interest rates are on hold at virtually zero for the next two years. This suggests that bond markets - while looking very expensive - are unlikely to see a significant sell-off in the near future. This is critical to the team's view on equities.
Says Percival: "Resilient growth in the US and continued growth in the emerging markets means that the world economy is not slumping as in 2008/09 - just slowing. With regard to China, we have been sceptical regarding the idea of a perfect "soft landing" that seemed to lie at the back of much wishful thinking last quarter. Since then, the consensus has become more pessimistic, with inflation slowing and infrastructure spending weakening. However, the consumer remains resilient and the authorities are slowly beginning to cut rates and relax policy.
"We expect more of this in the coming months, but in the absence of an external shock, we believe that the authorities will not move aggressively ahead of the leadership change at the end of the year. Elsewhere, other emerging markets are also cutting rates and given the scale of their underperformance over the last 12 months, valuations look particularly attractive, hence our upgrade."
In the developed world, Barings' Multi Asset Group sees the US market as looking cheapest, with Europe appearing less attractive. There are pockets of value in northern Europe, but the continent as a whole looks poor value over the long-term. The UK lies somewhere in between. The UK economy may avoid a recession, but it will be a close run thing. UK equities are relatively cheap with good exposure to global growth, although we are relatively cautious as the market's recent outperformance suggests it will lag a powerful rally in riskier assets.
Percival concludes: "We believe that we could see a relatively short recovery in risk assets over the coming weeks and months, based on improved liquidity from the ECB, the removal of the imminent threat to the banking system, cheap valuations, and depressed investor sentiment. This could be one of the few opportunities to generate significant returns this year, as the longer-term threats have not gone away and we could well find ourselves back in defensive mode by the second half of 2012."
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