Economic and Market Risks – Where are we?
Date:
13/08/2010
By Giles Heseltine, Director of Private Clients, Hottinger & Co. Limited
Increasingly frequent references are being made to the possibility of a double dip recession and the negative impact this would have on business and the markets. This worry has been primarily based on the sovereign debt problems in the peripheral Eurozone members (Greece, Spain, Portugal and Italy), a slowdown in China and increasing banking regulation.
For various reasons the risk of the global economy falling back into recession seems remote, however. Firstly, such events are extremely rare anyway as firms tend to have already made the biggest cutbacks the first time. Secondly, the IMF predicts that global growth will be over 4% this year and next, led by the US, China and the emerging economies. Thirdly, the massive fiscal stimulus packages that were implemented in 2009 are still working their way through into incomes and much of the prospective fiscal tightening will not take effect until next year. Finally, interest rates are likely to remain low for an extended period and thus monetary stimulus remains in place.
Despite this generally encouraging global outlook, the UK economy has been a little disappointing. It grew 1.2% on an annualised basis in the first quarter of 2010 and recent data suggest that the second quarter should show a similar figure. Whilst government spending still supports these figures this is likely to be withdrawn over the next few years whilst the private sector picks up the baton.
Indeed business spending has risen rapidly in the last few months whilst the purchasing managers’ index rose to its highest level for 15 years in May. The consumer meanwhile is more subdued with the Gfk survey showing consumer confidence fell to a four month low in June.
The emergency budget broadly set out the fiscal retrenchment needed and further detail will be provided in the Comprehensive Spending Review in October. The budget has been broadly welcomed by the markets with gilts and sterling particular beneficiaries as a Greek style implosion looked to have been avoided.
Our internal research suggests that whilst globally deflation rather than inflation is of more concern, in the UK inflation remains stubbornly high. We expect the Bank of England to leave rates on hold at least until 2011, however, bearing in mind the fiscal easing that is forthcoming.
From a market view point, the FTSE100 looks best placed to benefit from stronger global growth and equities do not look expensive on 12x 2010 earnings with many constituents having yields higher than the 10 year gilt. The coalition’s budgetary measures should help support sterling although we would expect gilts to drift a little lower over the coming months as the recovery takes hold.
In summary, the UK economic recovery is still tentative and inflation remains surprisingly high given the economy has just emerged from the worst recession for over 60 years. Further, the recent budget and the forthcoming spending review will place further downward pressures on the economy. Interest rates are likely to remain low for some time, however, and the corporate sector appears to be in a relatively strong position. Growth should therefore remain positive (if below trend) whilst the private sector continues its recovery and the outward looking UK benefits from growth elsewhere in the world.
giles.heseltine@hottinger.com