Western economic recovery could be tempered by weakness in southern Europe and US property market, analysts warn

Written by Ray Clancy

Thursday, 06 May 2010 10:00

The outlook on equities is more positive for investors despite a lot of caution over the longer term recovery prospects in Western economies, it is claimed.

Baring Asset Management has upgraded its position on equities from neutral to positive following its latest research which suggests there is a strong enough body of evidence showing the economic recovery in the West is well underway, albeit at a more subdued pace compared to past cycles.

However, longer term, it remains uncertain about how strong the US and European recoveries might be. There are still concerns that the scale and power of the rebound in the real economy might be very weak and prone to relapse on the withdrawal of government support.

‘We downgraded equities to neutral in August last year because the sheer power of the rally in risk assets required the overbought position to be removed either by a setback in market prices or by the passage of time. We finally got a correction in January and February but since then markets have been moving inexorably upwards,’ said Percival Stanion, Head of Asset Allocation at Barings.

‘Employment seems to have turned the corner with the latest non farm payroll showing solid job creation. Although the consumer is still weak due to balance sheet issues, retail sales are rising and car sales in the US appear to be rebounding towards a reasonable rate of about 12 million units a year, well up on 2009 and holding steady without government hand outs,’ he added.

The weak spot in the US remains the house market, which has slumped back over the winter months and shows little sign of recovery despite low servicing rates on mortgages, he said. ‘Still, its condition doesn’t seem bad enough to drag the whole economy back down again,’ he added.

Over the longer term, Barings remains uncertain about the strength of the US and European recoveries. It believes that in the US private sector, capital investment is likely to be very slow, while the public sector is likely to get squeezed back as state and Federal Budget issues come to the fore.

The outlook for 2011 is not robust. ‘While growth is likely to continue, it may be below the recent trend of 2.9%. This is not a disaster but corporate profit margin expectations next year might be vulnerable. Similar arguments apply in Europe and the UK where private sector recoveries will be moderated by fiscal tightening, especially in Southern Europe,’ Stanion warned.

Looking at global GDP growth forecasts, Barings concurs with the International Monetary Fund’s prediction of 3.9% for 2010, which would be stronger than the average for the 1990’s, a relatively strong period in global activity. However, Barings considers the IMF’s global GDP prediction of 4.3% for 2011 to be overly optimistic. Barings believes most of the large Asian economies have to tighten further.

‘While there is still plenty to worry about over the next few months and markets may be a little extended on a very short-term view, the direction of advance still seems for markets to grind higher. Equity risk premiums are back to reasonable and even slightly attractive levels in the UK and US and corporate bond spreads seem likely to narrow further,’ Stanion concludes.