LONDON, 12 April 2004 — Economic data published since the end of January has been rather on the weaker side. This is particularly true of business sentiment surveys. In Germany, the widely watched IFO index of business sentiment “rolled over” in February. So did the US ISM survey for the manufacturing sector. Manufacturing is of course only part of the overall economy (and proportionately much more important in Germany — at around 27 percent of GNP — than in the US). Nevertheless, the surveys rather confirm an impression that the peak of the present expansion — in terms of growth rates rather than levels — is now behind us.
However, we still expect the world economy to grow in 2004, with growth led by the US. Most forecasts show 4-5 percent growth from the US economy this year. Such growth (if achieved) would be very welcome, as it would probably produce some improvement in the US employment situation. Nevertheless, it would still be below the 6 percent pa rate reported for the second half of 2003.
The other pillar of the global expansion process is Asia, and especially China, which is now widely estimated to have grown around 9 percent in 2003. Most forecasts show growth falling somewhat in 2004 and again in 2005, largely because of increasing capacity constraints, which are reflected in forecasts of somewhat higher inflation. In general, one would expect a slowdown in China to be reflected in growth rates elsewhere in Asia. Nevertheless, Japan is right now surprising some by its strength. Recently published indicators of expansion include the series for unfilled job vacancies and for industrial production. Indeed, rising industrial production has led to a sharp fall in the inventory to shipments ratio, which in turn augurs well for Japanese production levels in future.
Europe stands out as being particularly weak — especially Germany and Italy. Unlike the US, scope for an expansionary fiscal policy is restrained by the Stability and Growth Pact. Moreover, the strong rise of the euro since 2000 has hurt European exporters. The odds are increasing of an interest rate cut form the ECB this year.
Looking further out, the next US president, whether Republican or Democrat, will probably have to address an unsustainably high budget deficit. Although fiscal tightening might be offset by a more expansionary monetary policy than otherwise, markets will at some stage start to discount a further reduction in US growth after this year.
Thus, our long-held view, that the present expansion will be shallow with growth rates much below the average of post-World War II expansions, remains intact. Nevertheless, there is a decent expansion underway in the US and Asia and markets should continue to be supported by very expansionary monetary policies. Thus, a wholesale shift in investment policy to anticipate a future US or global recession seems premature.
So far as equity markets are concerned, our base case is still that we are in a “correction phase” from which stock prices can move higher over the next six months. We did, however, remove materials and industrials from our list of favored global equity sectors last month, thus removing a cyclical bias in our investment strategy. We would expect to move further in this direction — emphasizing non-cyclical sectors and reducing the equity allocation — over the remainder of the year as opportunities for portfolio rebalancing present themselves.
Asset Allocation: 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.
Bonds: We have substantially reduced our recommended duration so that it conforms with the strategy for our “Core Plus” product. This is benchmarked against the returns on cash. We do not allocate any funds to AA and AAA corporate and supranational bonds as these bonds offer insufficient yield relative to government bonds.
Equities: Our regional emphasis is now on Asia, including Japan, as opposed to just the Tiger markets. In terms of global industrial sectors we favor energy, biotech and communications.
(Habib F. Faris is vice president at Clariden Bank, London.)
(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).
