Quantitative easing and loose monetary policy deployed in 2010 were successful, boosting markets to end 2010 at a high. In the first quarter of 2011 the global economy witnessed a number of significant events from the nuclear crisis in Japan to unrest in North Africa. Despite the continued challenges that face the global economy, including inflationary pressures and sovereign debt levels in Europe, markets have been surprisingly resilient. Focus on corporate earnings and profits news has broadly boosted confidence, however recently attention has turned to economic news with further talks regarding a bailout package for Greece. Representatives from the IMF, European Central Bank and European Commission have expressed their disappointment over the lack of spending cuts promised by Greece. Another agreement has been reached allowing the can to be kicked a bit further down the street but as before this is not a solution.
Economic indicators in recent months have pointed to a slowdown in growth and markets have taken this on board for example bonds have outperformed equities over the last three months. UK inflation figures having fallen from 4.4% to 4% last month have again moved up, now at 4.5%. This figure may bring forward an interest rate rise, however weaker economic data should counterbalance this. High levels of speculation, forcing commodity markets higher has largely been responsible for increasing inflation figures. Signs of weaker economic data combined with Goldman Sachs calling the top of the commodity cycle saw a sell-off sending the oil price down 10% in a single day and some precious metals as much 30% making commodities the worst performing asset class over one and three months. Having recently lowered commodity exposure our portfolios should be well positioned for any further correction in commodity prices. Tightening continues in emerging markets in attempts to control inflation and hence returns over the last six months have only been a quarter of that from global equities.
Despite weaker economic data and an increase in bond returns we remain negative on the outlook given the challenges faced by rising inflation, high issuance to fund budget deficits, historically low yields and the ending of US quantitative easing in June. Although inflation continues to be an issue interest rate rises are likely to be limited given a weaker economic outlook. This continued loose monetary policy should continue to support markets as investors are attracted to higher yielding assets. We still prefer higher income funds both in the UK and globally, which should benefit from inflows in the current environment.
We are conscious that low interest rates are causing some investors to take excess levels of risk in order to achieve higher returns and that riskier assets are likely to be hit hardest when the pricing of risk begins to normalize. Riskier assets such as commodities and emerging markets benefitted most from quantitative easing and they may well be the assets that are most sensitive to the ending of QE.
The EU sovereign debt crisis continues as the peripheral countries such as Ireland, Spain, Portugal and Greece continue to underperform in both financial and economic terms with unemployment in Spain hitting 21%. Germany on the other hand is ploughing on successfully with its unemployment level hitting a 19 year low and is also benefitting from the slowdown in Japanese production. Although company earnings have been hit hard in Japan and technically they have fallen back into recession we remain optimistic over the longer term that valuations will improve significantly from what are historically cheap levels.
Whilst we prefer equities over bonds we still hold a neutral position reflecting our view that economic risks are not fully priced into markets, however any correction could prove to be a good entry point for investors.