The extent of the recent collapse in more forward-looking economic indicators, coupled with a dramatic deterioration in labour markets, points to a grim fourth quarter for both the US and the UK.
The extent of the recent collapse in more forward-looking economic indicators, coupled with a dramatic deterioration in labour markets, points to a grim fourth quarter for both the US and the UK. Furthermore, the sheer scale of the decline seen in recent months suggests the downturn will continue well into the second half of 2009.
We expect economic output to drop by as much as 3% in both the US and the UK, which would represent the worst downturn since the early 1980s. However, we remain hopeful that aggressive government intervention by governments and central banks will begin to help revive demand by the second half of 2009.
Credit will be far more constrained for the foreseeable future, forcing a dramatic rise in household savings, while eye-watering levels of public debt are likely to act as a further restraint on consumption as governments raise taxes and slash spending once the recovery is underway.
Given this economic backdrop, there seems little doubt that corporate profits are likely to come under pressure and we do not expect any revival before 2010. From that point on, the tepid pace of economic recovery is likely to restrain corporate earnings growth. Dividends will also be weak as companies look to conserve capital, whilst corporate defaults will increase.
Much of this bad news is already priced in to equities. Equity valuations, for example, look as depressed as they have done in the past 20 years, both in absolute terms and relative to cash and government bonds. Nonetheless, while there have been some encouraging signs that equities are attempting to look through some awful economic indicators towards the prospect of recovery, we do not believe the market has necessarily reached a bottom.
In previous cycles, a sustainable rally in equities typically occurs around four months before economic output troughs. Given our view that this is probably still some eight months away, we believe it is still too early to say with confidence that a low point has been reached.
In any case, we see more attractive opportunities elsewhere, most notably within corporate bonds market where investment-grade credit offers excellent value even if one assumes corporate defaults hit record levels over the next five years. But even here there are grounds for caution, at least in the short term. Government deficits will balloon through 2009, while there is a clear risk that a wave of new issues begins to flood the market at the earliest opportunity given the multitude of companies that are desperate to raise capital. And while corporate credit markets do offer value, it is unlikely credit will be anywhere near as cheap for companies to access over the next five years or longer.
That said, for investors with a long time horizon this looks to be one of the most opportune moments in the past 20 years to invest in many asset classes, especially equities, corporate bonds and property. Take commercial property. While we believe the market is likely to struggle next year, the extent of falls being priced in means one can buy property forwards via the swaps market at a level that effectively equates to a yield of 9%, a secular investment opportunity. We likewise believe commodities may offer good returns over the long term, with many of the factors that drove prices to unsustainable records over the summer likely to reassert themselves, including diminishing supply, rising demand from China and other emerging markets etc.
Given our cautious stance over the near-term outlook, we believe market timing is crucial. In recent weeks we have been looking to increase our exposure to various asset classes at moments of extreme distress when we believe negative sentiment has been overdone. Similarly, we have been taking profits, shifting the funds into other asset classes, following sharp rallies.
We anticipate persisting with this type of tactical strategy during the first half of 2009. Shortly thereafter, we would expect a more sustained buying opportunity to present itself as clearer evidence that the pace of decline in economic activity is moderating begins to emerge.
-ends-
For more information contact:
Aline Sullivan
Corporate Affairs
+44 (0)20 7809 6170
Notes to Editors
Any future returns and opinions expressed are those of Aviva Investors Global Services Limited. They should not be relied upon as indicating any guarantee of return from an investment managed by Aviva Investors.
The source for all information is Aviva Investors as at 1 December 2008, unless stated otherwise.
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