Investment View

Monthly Investment View Update - November 2008

As part of our continued commitment to keeping you informed on the outlook of the global investment market, we've developed this new section on our website to keep you updated. Featured on this page, you'll find a global economic overview and commentary on our overall investment strategy.

The medium-term (3 years) economic outlook has continued to worsen in most regions over the past month. Organisation for Economic Co-operation and Development (OECD) leading indicators and purchasing manager surveys are falling quickly in emerging market countries, albeit from high levels. In developed countries, they are already consistent with recessionary conditions going into 2009. Lead indicators of aggregated world growth are consistent with falling global output for the first time since 2001.

Inflation concerns, seen by some as the main threat to economic stability over the summer, are now all but out of the equation. Central banks in both developed and developing countries have begun a series of interest rate cuts, and monetary conditions should remain easy during 2009. Investors have responded by driving breakeven inflation rates on index-linked bonds to all-time lows, with US 10-year breakeven inflation currently around 0.9%, compared with a low of 1.3% during the last recession.

The financial market strains of recent weeks should further restrict credit growth to the real economy over the coming months. Hence, we have downgraded our central expectation for GDP growth in the US and Europe. Growth is likely to remain negative during the first half of 2009 and below trend for some time after that.

Encouragingly, however, the policies of various governments and central banks have succeeded in reducing inter-bank lending rates. Three-month inter-bank lending rates in US dollars – the currency in which the liquidity squeeze was most extreme – are now back below their levels immediately after Lehman Brothers failed in mid-September.

Nevertheless, credit conditions in the real economy continue to tighten. Surveys of qualitative lending conditions are more restrictive than during the 2001 recession, and mortgage rates, though no longer increasing in the UK, Europe or the UK, appear to have stabilised at very high levels. The pace of decline in US house prices over the past quarter has slowed considerably relative to the past year, suggesting that the reduction in housing inventories is now easing the downward pressure on prices.

Volatility in equity and other asset markets rose to very stretched levels over the past month. with equities, bonds and currencies around five times as volatile as would be expected in normal conditions. The fall in equity prices has moved equities to their cheapest level, relative to 10-year trailing earnings, since May 1989. A holding period return analysis of the S and P 500 suggests that, though still not low enough to completely exclude three-year forward periods of negative returns, valuations are strongly supportive of medium-term returns.

Only during the economic collapse of the early 1930s have valuations at current levels been consistent with negative returns over a three-year period. With the success of proactive government policies already evident, we are confident that the current recession won't mutate into a destructive debt-deflation cycle as seen in the Great Depression. The valuation of investment-grade credit seems to be in similarly oversold territory. We expect markets to remain highly volatile into 2009, so the flip-side of positive long-term valuations is the likelihood of a short-term bumpy ride.

The opinions expressed here represent the house view at the time of preparation and should not be interpreted as investment advice. If you do require investment advice please speak to a financial adviser. As a Private Banking customer your relationship manager can arrange this for you.