In conjunction with the November Global Investment Strategy, Andy Brunner, investment strategist with OBSR, a Morningstar company, outlines our latest asset allocation views.
Equities
Recent events have done little to settle the debate about what lies immediately ahead for equity markets, except more volatility, while the medium term outlook remains fraught with uncertainty. Even so, a neutral equity position is retained given relatively low valuations and the belief that the EU authorities will eventually be forced to avert a disorderly financial crisis. An outlook for low economic growth, low inflation and low interest rates in a deleveraging world suggests a relatively defensive approach to geographic, sector and stock selection. This implies tilts towards the U.S., emerging economies to capture growth, defensive sectors and strong companies with healthy balance sheets. Good quality high yield stocks should also be favoured in a low yield environment.
Bonds
With main market government bond yields at such low levels, it makes little sense to increase weightings unless a U.S. recession and/or a eurozone financial collapse is expected. In recent weeks U.S., U.K. and German yields have fallen to generational lows and on fundamentals the massive bond rally appears overdone, especially with the scale of government debt and deficits. Given current growth uncertainties, still sizeable attempts at monetary stimulus via bond purchases and no sign of respite in the eurozone debt crisis, however, yields could stay at lower levels for a while yet. Investment grade corporates offer better value but upside is limited while emerging market debt should be reconsidered following recent falls and currency weakness.
Property
After such a strong yield impact-led recovery in capital values, the pace of advance in the U.K. property market has slowed to a crawl. The weight of money chasing high quality properties generated a near boom and prime yields seem very fully priced. With banks now becoming keener to supply the market with portfolios of properties from their involuntarily-built stockpiles and lower levels of investor interest at current prime yield levels, this will inhibit further gains in capital values and, indeed, they could well decline next year. Selectivity is important and Central London remains favoured. With yields in excess of 4% above ten-year gilts for even some prime properties, the sector should outperform cash and government bonds from current levels.
Commodities
Predicting commodity returns is difficult enough given the very broad spread, high volatility and problems associated with rolling over futures contracts on returns. It has become even harder as a result of the uncertainty created by EU sovereign debt issues, a weak U.S. recovery, a Chinese slowdown and a mass exodus by traders. Commodities such as crude oil and industrial metals fell very sharply during the recent sell-off but as long as the Chinese economy avoids a hard landing and the U.S. economy experiences nothing worse than a modest recovery, the pace of world economic growth should be sufficient to ensure that the prices of supply constrained industrial materials, such as oil and copper, will recover next year. Gold reached a new closing peak of $1,898/oz before its recent reversal but remains favoured by many investors worried that a far worse fate awaits the global economy. Scarce supply and strong demand will keep prices elevated until sentiment turns and real interest rates rise.
Currencies
Currencies remain as volatile and as difficult to predict as ever and near term trends will depend on the authorities' response to current financial turmoil. The yen is unlikely to strengthen too much further against the dollar given counteracting flows from the central bank, while the Swiss franc remains pegged to the euro. In recent weeks the euro has lost all its interest rate differential support and, with the eurozone crisis intensifying, sterling and particularly the dollar should outperform despite further QE. After its recent substantial rise, however, the euro is likely to be driven by market sentiment towards resolution of the eurozone financial crisis, i.e. it will remain volatile. Asian/emerging markets currencies are still undervalued despite short term capital flight and greater uncertainty.
