Standard Life Investments recommends that investors take a long term view
03 April 2007
Investors face medium term risks, related to the slowdown in the US economy and concerns about the sub-prime mortgage market, but positive trends in corporate sector profits and inflation should reward investors, according to research published today by leading investment house, Standard Life Investments.
In the latest edition of Global Outlook, its quarterly investment view, Standard Life Investments examines the main drivers of financial markets into 2007: whether the global economy can resist the slowdown in the US, which issues could cause further bouts of market volatility, and pressures on the corporate and household sectors.
Andrew Milligan, Head of Global Strategy at Standard Life Investments, said:
“There is considerable discussion amongst investors about the outlook for the US economy, and whether any weakness can be offset by strength in other parts of the world. Our view on the US remains more downbeat than the consensus, and we do not believe that all of the bad news is yet priced into financial markets. We expect to see renewed weakness in the second quarter, as the housing and manufacturing inventory cycles move down again. Such moderation is required as it would create some spare capacity in the economy, in due course providing the Federal Reserve with the headroom it needs to ease monetary policy.
“Problems facing the US definitely need to be put into context. In recent months economists have raised their growth estimates for most of the other major developed and emerging economies in 2007. There is evidence that the recovery in the European and Asian economies, especially Germany and China, is spreading out from the export and manufacturing sectors into domestic consumption.
“Certain issues could cause further bouts of market volatility going forward. These include not only weaker than expected activity in the US economy and concerns over sub-prime lending, but worries about the degree of financial engineering and leverage seen in credit markets as business activity slows and lending conditions tighten into 2007. There are also concerns about currency markets, for example whether a turnaround in the yen’s depreciation could trigger a reappraisal of leveraged carry trades.
“Despite these issues, we believe we are seeing a ‘normal’ rather than a ‘major’ correction in equity markets, and that any set-backs should be viewed as an opportunity for investors to review their allocations to equity markets. This is because we do not currently see evidence of excessive equity market valuations, or widespread inflation or credit pressures, or disruptive economic events which would normally signal a major correction at the end of the business cycle.
“We believe the longer term outlook for equities is positive. A healthy corporate sector can help extend the business cycle. Strong earnings growth has bolstered company balance sheets. While it will decelerate into 2007, we still forecast positive growth of about 5-10% p.a. An interesting development recently has been companies announcing sizeable dividend increases, usually a good medium term signal from management about the sustainability of profits growth. Share prices are being supported through ‘de-equitisation’, a combination of buybacks, private equity and M&A activity shrinking the number of shares in issue.
“A further support for the House View is our forecast that inflationary pressures roll over during 2007. There are pressures in some countries, but in general a combination of weaker business activity, continued migration and labour force participation does appear to be restraining wages growth while companies still report difficulties in pushing through price increases.”