LONDON, 19 January 2004 — Our investment strategy assumes a continuance of the global economic recovery in 2004. The upswing is being led by the US and Asia. US growth should reach 4 percent in 2004. Economic policy is now highly simulative. Inventories are still relatively low any normalization would boost output. Meanwhile, strong housing starts in the second half of last year imply good consumer demand over the next few months.
Asia is the other pillar of the global growth process. Chinese growth approaching 10 percent is, of course, nothing new but as the economy has more than doubled in size over the last 10 years, the impact on world output is now much more significant. India is also shaping up to be another fast-growing, giant economy. Growth there has averaged around 5 percent over the last decade but looks set to exceed 6 percent this year. Consensus forecasts for the “Tiger economies” on the Asian Pacific rim average around 5 percent for 2004.
Growth rates elsewhere are much less strong, though in most emerging market and developed economies the picture is improving. Thus, one can talk of a synchronized global recovery in 2004, involving almost all parts of the global economy.
As this is rapidly becoming the “consensus view”, it may be worth considering the risks that might prevent it coming to pass. An obvious risk is that of an accelerated slide in the dollar. This would have serious adverse effects on Europe (especially Germany) and Japan. Second, a sharp rise in commodity prices, especially oil, would also slow economic activity, though the investor can protect his portfolio through exposure to energy and raw materials businesses, as recommended in our equity sector strategy. We do not, however, worry much about inflation this year. Although the risk is of higher inflation rates down the road, reported price pressures should remain very low in 2004.
In our asset allocation, we advocate a minimal cash position and believe that superior returns are available in bonds, equities and in the alternative investment arena. However, attractive returns from bond investments may depend on a willingness to invest outside the highest quality (AAA and AA) investment grade area.
The key US Treasury market, off which most bond benchmarks are priced, now offers a relatively low yield. Moreover, the yield differentials (“spreads”) available in AAA and AA corporate and supranational bonds are very low. These “spreads” no longer offer sufficient compensation for the investment risk. Accordingly we recommend that AAA and AA bonds outside the government area be sold and reinvested in lower quality credits in the A to BBB area where the yields and spreads can still justify investment.
Still-higher returns, though with much more security-specific risk, are of course available in the high yield area. We retain a substantial exposure to sovereign bonds, generally in shorter dated maturities, as markets may remain volatile and sovereign debt still offers the best security in the event of a “flight to safety.” Our investment strategy is aimed at producing attractive returns over a rolling 12-month period. While the immediate cyclical environment favors equities, prospective returns over the longer term look modest. Rather than allow a cautious stance with regard to bonds and equities be reflected in a large low-yielding cash position, we have a significant allocation to low-risk alternative investments. We recommend just 5 percent in cash.
As for investments in bonds we recommend 50 percent of bond exposure to be in government debt.
(Habib F. Faris is vice president at Clariden Bank, London.)