outlook for us consumers are of key topics discussed in debate between threadneedle, newton and invesco perpetual
As 2006 gets underway International Investment brings together three leading asset managers to discuss their views on the global economy and markets over the next 12 months.
The debate ranges from whether or not the story in Japan really is different this time, to just how under pressure the US consumer is, whether the Indian market is too expensive and the very real problems that could derail the China story.
Taking part are: Kathryn Langridge (KL), head of international equity products at Invesco Perpetual, Peter Hensman (PH), global strategist at Newton, and Jeremy Podger (JP) global equity fund manager at Threadneedle.
What is your general outlook for world stock markets going into 2006?
KL: The world economy in 2005 has been hit with several major shocks and yet somehow, the big surprise of the year, has been the overall benign nature of the cycle. Inflation has stayed low, despite asset commodity and oil prices increasing quite radically.
Throughout this period, we have had a general tightening in monetary policy and one of the surprises has been that the Fed has managed to negotiate the trade-off between growth and inflation. The result has been an extended benign cycle, which has been very good for equity markets. Looking into 2006, we do not really see too many reasons why this should change.
PH: We feel growth is going to slow down slightly. Our outlook on 2006 is much like our outlook for 2005 was 12 months ago. The difference we feel this time is that the US is much further through its rate increase cycle and the experience of the UK over the course of the past 12 months is a good model for where the world will head to over the next year. It is not an environment where you are going to see a sharp slowdown in growth but one where it disappoints some of the higher expectations out there.
JP: We see the engines for world growth, China and the other emerging markets, essentially very much intact. And although we are a little bit below consensus in our views on the US, we are still talking about a 3% growth rate approximately for next year, which is good by anybody's standards.
What will happen to the Japanese market over 2006?
JP: There have been a number of false alarms on the way down and for two years corporate profitability has been picking up.
If you look at corporate profitability against imputed cost of capital in Japan, corporate Japan was destroying value for the majority of the past 15 years. We have now turned the corner and from what we can see on a bottom-up basis, there is still an awful lot left to go for in terms of profitability. Despite the fact the market has had a strong run, there is still more to go, principally in the domestic sectors.
PH: To me, the thing that changed was back in 1997 when you had a financial crisis. The banks got forced to change their approach to corporate business and what we have seen in the intervening period is Japan working through the problems that were caused. This has created a big pick-up in profitability that will certainly carry on into the future, despite the fact Japan is still a very cyclical market and will be influenced by events on the world stage.
KL: We have been considerably more cautious than consensus on Japan in 2005. And that is because we believe the change taking place is more substantial than we have seen in previous false dawns in Japan, it will nevertheless be much slower to take effect than the current very bullish consensus now expects.
Valuations for the market as a whole are very high at about 20 times, although we recognise that if there is the sort of shift that could take place in capital management in Japan, then you could see returns on investment radically changing the profitability landscape in years to come.
What about the situation in the US concerning consumer debt?
PH: We are underweight US, as we have found more interesting stocks elsewhere, particularly in the emerging markets and Asia. Key for us is this issue of how much debt has been built into US households, which is likely to grow in importance as we head into next year, particularly as the Fed has raised rates. We are starting to see signs those rate increases are causing the housing market to top out, which was a very important factor in why the economy has got to where it is. We still feel that is likely to be a drag on US activity and on US equity market performance over the coming 12 months.
JP: We acknowledge the profit cycle in the US is at a fairly mature stage. While we are relatively cautious on the consumer side, we do not expect any sort of crash in consumer expenditure.
But having said that, when we construct our portfolios, what we are emphasising in the US are companies where we think revenues and profits can continue to grow from here. And so we are talking about areas such as technology and healthcare. Typically we are more cautious on retail, even though there are some good companies in this area too.
KL: We are also underweight the US and that has been a longterm core position in our global portfolios. At the moment it is predicated on the view of the consumer and US savings rates. If you look at personal consumption in the US, it has moved to 71% of GDP at a time when savings rates are at a historic low.
Interest rates are high and energy prices are making an impact on disposable income in the US, arguably there is a housing bubble, which the Fed has been trying to address. All of which suggests the pressure on the US consumer will intensify into next year and as a result, we have absolutely no exposure to the US consumer in our portfolios.
What are your views on India as an investment opportunity?
KL: The long-term story for India is an extremely exciting one, with the region establishing itself as a global leader in several areas. Short term, however, valuations are looking a little stretched. The Indian market has performed spectacularly well, both this year and last, and has been one of the favoured emerging markets. I do not think that detracts from the long-term credentials of India which is an extremely fertile place for investment, but in the short term it is a little overdone.
PH: India has a lot of advantages in terms of set up and where it is likely to head to. It has performed well and contrasts with the Shanghai Asia index that is down 50% from its peak, because of the less disciplined way that China is going about its growth.
JP: India unfortunately is no longer the country it used to be in terms of its role in global portfolios. India used to be one of the best portfolio diversifiers you could possibly find. The market would go up when every other area was going down and vice versa. When other emerging markets looked expensive, India was cheap and when other emerging markets were cheap India was ludicrously highly valued.
India's economic cycle was based on politics and the success of the monsoon. From a global allocation perspective, this was extremely useful but sadly it is no longer true.
What threats are there to the long-term prospects of India and China?
KL: The biggest potential risk for China is the rise of US protectionism. Around 35% to 40% of China's exports go to the US. While that might be a good thing for Wal- Mart and the US consumer, it is less so for the man in the Mid-West who has just lost his job to a Chinese worker, and he is perhaps more of a powerful political influence as the US trade deficit widens next year than the voice of the Chinese worker and the US consumer.
PH: This is undoubtedly a major issue, but I just do not think it is very likely to occur over the course of the next 12 months. At the last election you had John Kerry saying we can go on to a more protectionist agenda and we saw that he lost substantially.
So I do not think it is something that politicians are really willing to push. In my mind, probably the biggest risk for the stronger outlook for China is the banking system. Most Chinese corporations are making huge losses at present and this could be one of the reasons that corporate profitability in the rest of the world is so high even though China's trade share has been increasing.
Expect benign backdrop of 2005 to continue during 2006 - Invesco Perpetual.
China and emerging markets to continue as engines of global growth - Threadneedle.
No sharp slowdown in world growth but some of the higher expectations could be disappointed - Newton.
Japan is genuinely reforming, Invesco Perpetual more cautious on the speed of change than Threadneedle and Newton.
Newton expects US housing market to be a drag on the economy in 2006, Threadneedle sees no crash in consumer spending but Invesco Perpetual avoiding US consumer altogether.
India a good long-term investment but looking expensive after a strong run and no longer the portfolio diversifier it once was.
There are dangers in China: threat of US protectionism is real, the banking system is under pressure.
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