By John Sherman, global head of fixed interest at Henderson Global Investors Equity markets worl...
By John Sherman, global head of fixed interest at Henderson Global Investors
Equity markets worldwide plummeted in July as persistent concerns about the transparency of accounting practises and the reliability of corporate earnings were compounded by fears the global economic recovery would be weaker than previously thought.
Inevitably, government bond markets rallied sharply, but corporate bond spreads widened across the board and the new issuance market virtually closed to all but the most dependable companies.
The US economy and, by extension, the global economy, will continue to recover, albeit sluggishly, in the second half of the year. Recent economic news in the US has been disappointing but does not suggest a slide back into recession.
There is still a risk this could happen, of course. As in the aftermath of the 11 September terrorist attacks, consumers will play a critical role in determining the outcome.
So far, they have been responsive to looser monetary policy, actively refinancing their mortgages and thereby unlocking some of the equity in the robust housing sector and taking advantage of attractive financing options to purchase large-ticket items.
However, there is a danger the steep equity declines and a slowdown in the employment market could prompt consumers to cut back their spending. Additional accounting scandals and escalating political tensions between the US and Iraq, as well the ongoing conflict in the Middle East, could erode their confidence even further.
The asset allocation for our Managed Income portfolio reflects our view that confidence will improve over the next six to 12 months and that, in response, equity and corporate bond markets will rally.
We recently increased the weighting of the European High Yield Bond fund to 40% from 38% and expect it to benefit from having a well-diversified exposure to industrial cyclical and energy stocks.
In the long term, the sector should also outperform due to strong technical factors, such as generally robust demand for corporate issues, driven by the FRS 17 accounting standard, which is pushing down absolute yields on AAA-rated bonds, and subdued new issuance levels.
We also increased the weighting of the UK Equity Income fund to 18% from 15%. The fund invests in shares of companies with resilient cashflow-generating properties and stable dividend policies. It is fairly defensively biased to reflect our view that the global economic turnaround will be sluggish, with overweight positions in utilities, consumer staples and tobacco.
UK equities were especially hard hit because insurance companies came under regulatory duress to protect their solvency requirements by shifting into government bonds. Consequently, valuations are looking attractive.
The remainder of the fund is allocated between the Henderson Preference & Bond fund (30%), which invests primarily in sterling-denominated corporate bonds, convertible and preference shares issued by UK and European companies, the Henderson Corporate Bond fund (10%) and cash (2%).
Recovery to materialise in second half of 2002.
High-quality firms at attractive valuations.
Strong factors underpin high-yield recovery.
Economic recovery will be subdued.
Earnings credibility may remain weak.
Consumer confidence could weaken.
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