RBS Coutts’ global investment strategy team published its 2011 Mid-Year Investment Outlook, highlighting the key drivers of investment returns for the remainder of 2011. Coutts discusses it here.
Jean-Maurice Ladure, head of Investment Strategy for Europe at RBS Coutts notes there are two big issues that continue to impact the returns available to investors. “These are how to refinance insolvent European countries without creating another pan-European banking crisis and also the US fiscal deficit. Neither of which are easily solved and so it is important that investors have access to investment funds and solutions that take these into account.”
The Coutts 2011 Mid-Year Investment Outlook focuses on a number of investment themes, including stagflation, currency depreciation and the global recovery.
Global growth has been sustained but it is not sufficiently strong to dispel concerns about ‘stagflation’ in the West and so investors must continue to act with caution. Inflation is often a debtor’s friend, and therefore currently the friend of most Western governments – and much safer than the alternative, deflation.
“In our view, a deficit reduction programme aided by 3-4 per cent inflation is a more achievable fiscal adjustment route than the alternative that is currently being forced on peripheral Europe – nominal public sector wage cuts, which in Greece are close to 20 per cent, and recession,” says Carl Astorri, the global head of Economics and Asset Strategy at Coutts. Negative real yields, delivered via moderate inflation and combined with artificially low bonds yields, are often part of the solution that governments pursue to reduce overwhelming debt burdens, according to Coutts. It is a covert way for a government to ‘default’ on its obligations to the domestic holders of its debt and is often combined with regulatory incentives that compel institutions such as central banks, pension funds or commercial banks to hold government debt when it makes no economic sense to do so.
The other covert route used by governments to help ease the way out of overwhelming debt is via a depreciating currency: overseas bond holders take an additional foreign exchange loss and the economy benefits from improved export competitiveness. So, while the US cannot agree on a deficit reduction plan, there are no voices standing in the way of a steady fall in the US dollar. However, for Europe’s periphery there is no currency to devalue and no benign inflation, which leaves all parties – governments, banks and the European Central Bank – still looking for an elegant way to manage the pain of a much less covert ‘default’.
Coutts expects the global recovery to remain centred on China, wider Asia and emerging markets in general, where it is believed inflation will peak later this year. Asian markets continue to trade at a valuation discount to other countries, despite having faster-growing economies and higher returns on equity. The anticipated strengthening of local currencies is an additional source of potential returns.
The European fiscal crisis is no longer just about the solvency of peripheral euro-zone member status, but also the solvency of the banks and the European Central Bank. The best option is to try to muddle through until 2013, by which time a voluntary restructuring for Greek debt could be organised without banks going bust.
“Reality is likely to be one of repeated crisis until a big one forces fiscal union,” says Ladure. “We think the most likely catalyst would be an attack on Spanish government debt – the line that policy-makers must not allow the crisis to cross.”
Coutts expects 2011 to be another positive year for risk assets but a repeat performance of 2010, with high single or double digit returns from most asset classes, is unlikely. In developed equity markets, Coutts predicts yield and value to outperform growth, and equities are likely to offer greater protection for returns than fixed income. Other highlights are that prime property will also be prized for its secure income stream and slow growth in developed economies will heighten the attractions of emerging-market equities and currencies.