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In the balance

Recent purchasing manager surveys have skirted around the 50 level that separates expansion from contraction. This indicates how finely balanced the current state of the global economy is. The positive momentum of the earlier part of 2011 has given way to nervousness that developed economies could be slipping into a double-dip recession.

This pessimism has been driven by deterioration in the economic data together with the malign influence of politics. Squabbling between political factions in the US over raising the US debt ceiling and the lack of a united front among eurozone politicians have failed to inspire confidence, the ill-timed suggestion by Merkel-Sarkozy of a tax on financial transactions merely underlining the view that politicians are removed from the notion that companies perform best when costs are kept low.

One could argue that the trend between 1980 and 2007 of politicians interfering less and less in the markets was broken in 2008 as governments took stakes in companies and initiated a new wave of regulation. The change seems to be semi-permanent rather than temporary and could arguably have raised the equity risk premium as investors and businesses struggle to second-guess policymaking.

Central bankers seem to be acting more sensibly. The European Central Bank has backed away from further monetary tightening, the Bank of England has not ruled out a second round of quantitative easing and the US Federal Reserve has promised to keep interest rates low until mid-2013. With real narrow money growth above the pace of growth of industrial production in the G7 industrialised nations, there is reason to believe financial markets can begin to recover as excess liquidity finds its way into asset prices.

The corporate sector is also still in relatively good shape. Cash on corporate balance sheets and limited hiring since the financial crisis mean it is difficult to envisage a sharp downturn in investment spending or a surge in layoffs. Moreover, the emerging market economies continue to record enviable rates of growth and with the pricing pressure from commodities easing, the need for further monetary tightening in emerging markets should dissipate. Economic growth among developed economies may be stagnant this quarter but two consecutive negative quarters looks unlikely.

Given the fragile outlook, however, it would seem a mix of asset types is appropriate. We believe the yield on equities is attractive and offers a solid rate of return allied to some degree of protection against inflation. Gold continues to attract investors both as a hedge against inflation and deflation and is increasingly seen as an alternative currency.

The bond market is difficult to read and we are surprised investors have been prepared to accept a negative real return from government bonds. It seems those that are worried about deflationary outcomes are buying government bonds just as inflationary concerns are driving other investors into gold. Both asset classes ought not to be performing well at the same time but it is a sign of the present uncertainty that they do.

Bill McQuaker is head of multi-manager at Henderson Global Investors


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