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Global equity markets outlook - Threadneedle

Tuesday 9th February 2010
By Mike Jones

Global equity markets posted strong returns from March 2009 onwards, resulting in the best calendar-year return from the MSCI AC World Index since its inception in 1987.

However, despite the strength of the rally, the market only regained a proportion of its previous losses, ending 2009 more than 20% below its 2007 peak, said Jeremy Podger, Head of Global Equities, Threadneedle.

Looking ahead, Podger revealed the following on global equity markets:

Narrow leadership
"The rally was initially led by lower quality, cyclical and financially distressed stocks. Many of these companies continued to see earnings downgrades throughout 2009. Thus, the key driver of their outperformance was not earnings momentum but rather the change in outlook from likely failure to probable survival. This trend continued throughout 2009 but we believe that it has now run its course, with high quality, well-capitalised companies that offer genuine long-term earnings growth likely to take up the running in 2010."
Fund flows to improve
"Retail investors have been conspicuous by their absence in the equity market recovery to date. Even in emerging markets, which experienced significant inflows in 2009, this has only reversed the outflows seen in 2008 and early 2009. There is evidence to suggest that corporate bonds were the prime beneficiaries of retail inflows in 2009. The move from cash to bonds is a sensible first step in redeploying risk capital. With corporate bond valuations now less compelling after last year’s spectacular spread contraction, we believe that allocating to equities may be the next logical step."
Cost cutting protects profits
"The market has been surprised in this cycle by the extent to which companies have managed to protect their profits by cutting costs. Many areas of the cost base that were previously regarded as fixed suddenly became discretionary. We believe that the resulting focus on efficiency and productivity will be a lasting legacy of this business cycle. As economic growth and demand recover in 2010 and beyond, the operational gearing impact of these measures will feed through to enhanced profits."
Economic background supportive
"Our forecasts for developed world economic growth in 2010 are below consensus as we believe that deleveraging at the consumer and government level will constrain demand. Although unemployment is likely to peak in the US this year, labour markets throughout the western world will remain weak and excess capacity will continue to be a feature of developed economies. We therefore do not expect inflation to be a problem this year and believe that interest rates will be maintained at historically low levels. This is generally supportive of risk assets."
Emerging markets to lead the way
"Meanwhile, we are confident that emerging markets will continue to generate superior levels of growth. In fact, we believe that emerging markets will be the main driver of global growth for some years to come. We see recent measures to remove excessive stimulus in China as sensible and believe that the long-term growth story in China remains very much intact.  Strong demand from China and other emerging markets, combined with gradually recovering activity in the developed world, bodes well for corporate earnings. Indeed, we are forecasting earnings growth of 20% or more in the UK, US and Asia in 2010."
Valuations reasonable
"Most major markets currently trade at between 14 and 16 times 2010 earnings. This is by no means stretched for this stage of an economic recovery and suggests that, with interest rates remaining low, there is scope for PE multiples to expand. Thus, there is potential for markets to make progress even in the absence of a continued recovery in earnings. Factoring in our estimates of earnings growth provides further upside to markets."
Key risks
"Our central case is that the stimulus measures that have been put in place prove sufficient to revive the world economy without sparking high levels of inflation, and that the authorities succeed in withdrawing the stimulus in an orderly way.  However, clearly there are risks around this central case and investors are likely to be periodically concerned about the possibility of a double dip recession or the potential for rising inflation. Indeed, the market’s short-term reaction to evidence that China was removing some of its stimulus in January shows how nervous investors still are. Meanwhile, equity issuance is likely to remain at relatively high levels and, should demand for equities wane, this issuance could prove hard for markets to digest. These concerns may lead to further bouts of volatility in the months to come."
Six exciting themes
"Despite the risks outlined above, we remain positive on the outlook for equities and have identified a number of investment themes that we are reflecting in our portfolios. For example, at a sector level, global technology stocks offer attractive valuations and very strong cash flows and balance sheets, while Hong Kong property is a key beneficiary of accommodative global monetary policy. Elsewhere, Japanese exporters struggled against a strong yen in 2009 but we see potential for this to change in 2010; we have also unearthed companies in a number of global sectors whose valuations are failing to reflect the value of their underlying assets. Meanwhile, we are finding selected companies where we are confident that earnings have bottomed but the shares are still trading at a sub-market multiple. Finally, with well-capitalised long-term winners set to pick up the performance baton in 2010, we have identified blue chips as a source of particular value at this stage in the cycle."
A successful high alpha product
"Threadneedle’s Global Select Fund is the company’s flagship global high alpha product. Although the fund underperformed the market in the low quality rally of 2009, its long-term track record remains very strong. Indeed, it has outperformed in five of the six calendar years since the inception of the team. Moreover, this record has been achieved with low levels of volatility, resulting in an impressive information ratio."
"With economic growth recovering and valuations in reasonable territory, we believe that equity markets will deliver good returns over the remainder of 2010, although bouts of volatility are likely as stimulative policies are scaled back. We have identified a number of exciting themes that we believe will allow us to continue to add value in our global equity portfolios. Our proven team and process should be well-equipped to perform well in what we expect to be a stock-driven phase in the market."

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