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Barings warns of fragile US economic recovery

Thursday 25th February 2010
By Mike Jones

Baring Asset Management’s latest global economic research reveals that the US recovery is still well below "normal" for the current point in its economic cycle. It warns that the economy still has to pass several key tests to prove it can stand on its own feet as the authorities withdraw support. For example, the auto sector has proved resilient following the end to the "cash for clunkers" programme, but now the test will be how it performs when the Fed ends quantitative easing.

Also, mortgage rates are expected to rise by 25-50 bps and the impact this will have on the housing sector will be followed carefully. Similar arguments apply to the employment situation – layoffs have eased back but there is little sign of job creation.

Percival Stanion, Head of Asset Allocation at Barings said: "We think that the US should be able to weather the strain, but it needs watching carefully."

Commenting on core Europe, Barings said it was relatively resilient, but there was little sign of a pick-up in consumer spending in Germany despite tax cuts. On the fringe meanwhile, it warns that things are likely to get worse before they get better.

Stanion said: "The Greek crisis is a key test of European nerve. There is huge pressure now being exerted to force Greece to raise taxes and cut public sector salaries. This is the only way the country can restore some competitiveness and control public debt levels. But it will be painful politically to force these measures through. Once Greece has accomplished this, attention will then turn to Spain, a far larger economy and where there is the added complexity of regional autonomy. Activity in both countries and Ireland will almost certainly still be down again in 2010."

In the UK, Barings said the flexibility of a floating exchange rate helped at the margin, but unfortunately manufacturing had shrunk dramatically in recent years and now only accounted for a very small part of GDP. Even that was probably relatively specialised and price inelastic.

Stanion said: "Last year, the UK did not get much benefit from a 30% fall in trade weighted Sterling, though that is probably due to the recession causing an indiscriminate hacking back of orders. It will help this year but in the short-term the economy has to overcome the impact of the weather, the VAT rise and the looming election. After the election, pressure for budget cuts and a coherent medium-term financial plan will become intense and backed by a non trivial risk of a rating down grade."

In emerging markets, Barings said the economic recovery was more "V" shaped. China, India and most of Asia plus parts of Latin America are all recovering well. In China, the authorities have already announced measures to curb excessive lending, and Barings expects more action here.

Stanion said: "In market terms, worries over Chinese growth plus the tensions over Greek sovereign bonds have been the catalyst for some significant profit taking, the first since the rally began last spring. Certainly investors have cause for concern as risk assets (equities and corporate bonds) are no longer cheap after the huge rally. Equities have achieved fair value on the assumption of a huge recovery in margins and earnings. This is probably justified given the cost cutting achieved recently, but there needs to be more visibility of the resilience of global growth, particularly with the prospect of government support being withdrawn for markets if valuations are to be pushed to new higher levels. We remain positive on equities for the long term but cautious in relation to bonds and cash."

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