Some investors will be wondering whether it is really necessary to review the year 2002. Investors in equities in particular will not be keen to recall their painful losses, especially considering that this is no more weak phase for equities but the third “annus horribilis” in a row.
The fact is that world economy was spiraling even before the tragic events of Sept. 11, 2001, and shortly afterward, tottering consumer confidence was dealt a further blow by the Argentinian crisis. Some investors not only suffered severe currency losses when dollar parity was abolished, but they then also had their assets confiscated when the Argentinian government blocked bank accounts.
The central banks took rapid action to prevent a worldwide recession. The US central bank (the “Fed”) gradually reduced interest rates by 225 basis points, while the European Central Bank cut rates by 150 basis points.
Those monetary “tranquilizers” were necessary because the news coming from companies was far from good. On the contrary, a wave of shocking disclosures about large and renowned companies such as Enron, Tyco and WorldCom rocked already feeble investor confidence to its foundations and unleashed extreme volatility.
Since then a whole series of uncomfortable questions has been raised in the economic press: Creative accounting, scandalous company management, pension and option schemes and disappointing profits are just a few of the critical issues.
The logical result of all these events was increased risk aversion among investors, leading to widespread offloading of equities and a flight into safe bonds and safe currencies. Since the start of the year, the US dollar has lost about 13 percent against the euro and some 14 percent against the Swiss franc.
On top of the bleak news on the company front, mixed macroeconomic data about worldwide industrial production, the labor market and price trends are making it difficult to forecast future developments. New geopolitical risks in Brazil and the danger of war in Iraq have fueled volatility again and sent ten-year yields tumbling to historically low levels.
Annual performance is what one would expect against this background. Since the beginning of the year 2002, the MSCI world has lost 18.3 percent, while the Salomon World Government bond index rose by 17 percent.
As for equities, non-cyclical consumption (-4.05 percent) and raw materials (-4.07 percent) produced the best performances, followed by the energy sector (-6.2 percent) The IT sector put in the worst performance, a spectacularly bad -34.7 percent.
On the bond side, interest rates for most currencies and for most durations fell, which meant that bond investors pocketed juicy price gains. Maturity periods of 10 years and more posted a phenomenal performance of 19.75 percent, which was the best of all, but investments for shorter durations bought yields of 13 percent, which are not to be sneezed at.
The moderate economic growth in 2002 was mainly driven by a veritable boom on the property markets and tenacious domestic consumption.
What will be the driving force in 2003?
Given the sensational developments on the property markets in 2002, we consider it highly unlikely that this trend will continue in 2003. The property market now seems to have attained a certain maturity and will not contribute significantly to economic growth.
Consumption has often sprung positive surprises but we anticipate that the growth rate for consumption will be lower than in 2002.
It looks as if the buoyant force in 2003 is more likely to come from fiscal policy. Expansive monetary policy led to negative real interest in places in 2002 — which boosted demand. Now the economy is likely to be underpinned by even more expansive fiscal policy. The resignation of Finance Minister O’Neill and the Bush administration’s determination to push through further tax cuts can be seen as signs of this fiscal policy trend. Given the Republican majorities in Congress, these plans should be implemented without difficulties. Moreover the financing of a possible war with Iraq will further reinforce expansive fiscal policies.
To what extent will this stimulation help? The question of dosage will be decisive. Demand will certainly be directly stimulated. However it is in everyone’s interest to avoid an over -expansive fiscal policy which, given the high budget deficit would lead to a steep rise in interest rates. If this happened, fiscal policy would put the brakes on consumption and investments would be cut back.
We have not made any changes to our investment policy for last month. We consider a cautious approach to the equity markets to be appropriate and we are therefore leaving the equity component unchanged. This also takes into account the low end-of -year liquidity levels, which militate against any dramatic re-allocations. However we remain confident that the long-term perspective favors equity investments.
The low valuations (high risk premium) and the expectation of moderate economic growth in 2003 suggest that the situation on the equity markets will brighten up. As for sector allocation, the overweighting of the energy sector last month as oil prices rose proved particularly profitable. On the other hand, the overweighting of the pharmaceuticals sector did not pay off, so that overall no surplus yield was generated.
As for bond strategy, we remain positioned close to the various benchmarks on duration but recommend slightly lower durations. The argument for staying close to the benchmarks is that at the short end of the interest curve the potential for price gains will probably be low while at the long end volatile lateral movements are more likely in the near future. Given the steepness of the curves, longer investments will be rewarded with a higher yield, without investors having to reckon with major price losses. The slightly shorter duration than the benchmark is based on the long-term expectation of an economic revival, which will result in rising interest rates.
As for the risk premiums for corporate bonds, we recommend selective involvement in short US dollar securities with lower ratings but for the moment we are sticking to our overweight for good quality bonds.
(The information contained herein is for information only and should not be construed as an offer or a solicitation to purchase, subscribe, sell or redeem any investments. While Clariden Bank uses reasonable efforts to obtain information from sources, which it believes to be reliable, Clariden Bank makes no representation or warranty as to the accuracy, reliability or completeness of the information)
