Like a tapas bar owner in central Pamploma, FT Alphaville is well-attuned to bullish sounds.
2011 outlooks are accumulating in the Long Room, where you can sniff a strong whiff of qualified optimism for the year ahead. Even the hitherto pessimistic Goldman Sachs flared its nostrils a little this week.
New to the table on Friday is Barclays Capital, which offers this cautious suggestion for equities in the year ahead:
EQUITIES ARE BACK
Equity risk premiums are high enough to warrant an overweight position in equities relative to fixed income.
Our call for equities outperforming fixed income looks stronger in the US than in Europe, where the ECB’s tepid approach to its own version of Large Scale Asset Purchases is unlikely to be a catalyst for a reduction in the equity risk premium.
We recommend paring back exposure to the developing world, and favour investing in emerging markets through developed world companies with significant exposure to emerging economies.
As deleveraging in the consumer sector and public sector continues to unfold, we are mindful of the market’s propensity to react aggressively to inflection points and expect increases in volatility as a result.
In an environment of diminished correlation between asset classes, we expect relative value and carry trades to be more effective.
So, rich world equities are back – sort of.
But just how qualified this call is for the year, and how tricky it is to allocate assets, is contained in the details of the full (draft) report.
In fact, it’s not really even a recommendation for the full year – H1 is predicted to be way more benign than H2.
We are currently in a period of economic recovery, low inflation and extreme policy stimulus. As 2011 progresses, we are likely to see signs of slower growth in the economies that led the economic recovery (the major emerging markets) and we could well observe signs of higher inflation generally by the end of the year. Other pressures could well emerge that force policymakers to pull back from the extremely supportive policies in which they are now engaged. The environment looks quite favorable for equities now, but as we proceed through 2011, investors need to be alert to a change, which could appear quite suddenly.
Indeed.
And this short-term strategy for this unknown known world reflects not so much a perceived strength in equities as a perceived weakness of the fixed income and credit markets. Charts from the report:
Evidence for this strategy comes from continuing consumer delveraging and less-bad-than-first-thought labour market results. Oh, and the ongoing presence of QE2 to prop up the stock market.
Faith in that particular strategy comes from a familiar source (quote from the report):
In fact, a potential catalyst does exist, LSAP. For those that doubt the Fed’s goal is to resolve this relative undervaluation of equities we suggest referring to a paper penned by Fed Chairman Bernanke, Vincent Reinhart and Brian Sack in 2004 on Japanese currency intervention. In that paper the authors proposed that measuring the effectiveness of intervention solely in terms of the impact on the yen was too narrow a focus and that the impact on Japanese equities was a more important factor to Japanese economic activity. To be sure, there are plenty of recent references by the Fed to make it quite clear that a primary goal of LSAP is to raise equity market valuations and we do believe they will be successful, at least for a time.
The message: take advantage of the sort-of-working QE2 before inflation starts ticking up.
A risky strategy, perhaps. Especially given that historical valuations suggest US equities are not particularly attractive (table again from the report):
The idea that US equities are the least unattractive last resort right now also reflects what BarCap thinks is going on elsewhere. In emerging markets, for example, it thinks investors are too highly geared in, and these markets are due for a slight come down.
If Chinese QT continues this could be a good call – but rising flows do not always mean that they will fall soon.
What of Europe? Cautious optimism reins here too, though its Iberian analysis may warrant some scepticism. For instance: “We believe that Portugal’s core economic problem is low productivity growth”. (OK.). Or, “The [Spanish] residential real estate sector has significant buffers in the event of default.” (OK.)
Anyway, we digress. And BarCap does stress that European equities are still a decent bet, providing they’re more counter-cyclical than in the US and have strong EM exposure (i.e. depend on the European economy as little as possible).
The interesting undertone to this – and other – reports is the fear of a false dawn in US equities as investors attempt to chime encouraging economic data with the looming eventual removal of QE2. This latest safe haven might not be so safe for so long, after all.
Full report in the usual place.
Related links:
Looking ahead to 2011 – FT Alphaville Long Room
Goldman hedges its bets – FT Alphaville
A surprise bullish turn – FT Alphaville
The return of (cautious) optimism – FT Alphaville
Deleveraging and the tax compromise – FT Alphaville