2011 will be a year of moderate economic growth, low interest rates, above-average equity returns and good prospects for credits. Indeed almost a repetition of 2010. This is Robeco's outlook on the investment year ahead of us. Ronald Doeswijk, senior strategist at Robeco, explains.
Investors are not heading for a negative year, but not a spectacular year either, predicts Doeswijk. Some economists fear a double dip, but he considers such a scenario unlikely. "Double dips are a rather rare phenomenon. Moreover, corporate earnings have returned to pre-crisis levels and macro figures have been relatively strong in recent months. Producer confidence in the US, Germany and China is positive, US retail sales are encouraging and German unemployment has dropped to its pre-crisis level."
That sounds good. However, the need for developed countries to tackle their towering budget deficits has a dampening effect on economic growth. "Therefore I do not expect growth to boom, but to develop at a moderate pace", says Doeswijk.
Emerging markets are the exception to this rule. According to Doeswijk they will continue their way up as a result of the expanding middle classes. Equity markets in these countries outperformed the MSCI All Country World Index by far last year. According to Doeswijk, such an impressive performance is not in the line of expectations for this year. Still, emerging markets will continue to excel as they have suffered less from the credit crisis, are not weighed down by a huge debt burden and are largely unfettered by a mushrooming ageing population.
Currency tensions have been a theme occupying the financial markets for some time now. Doeswijk expects them to continue simmering in the coming year, flaring up now and again. This may increase volatility in currency markets. However, the conflict will not impact economic growth significantly: "The USA and China will not allow this situation to deteriorate into a global trade war. In the end, enlightened self-interest is likely to prevail."
One other topic is the question of whether we are to factor in inflation or rather deflation in the future. According to Doeswijk, the chances of the first scenario are the largest. He has four arguments supporting this view. "To begin with, inflation is fueled by central banks buying government paper. The Federal Reserve is leading the way, reluctantly followed by the ECB. Secondly, commodities are once again threatening to become deficient, which may lead to rising prices. Thirdly, wage costs may be rising as labor becomes more scarce due to the ageing of the population. Fourthly, we must realize that inflation is not such a bad scenario for countries with high debt burdens. In fact, it means that their real debt declines."
Doeswijk adds though, that inflationary threats will probably not yet emerge in the year ahead of us. "We do not expect inflationary risks until 2012." This leads Doeswijk to believe that interest rates will not be hiked in the US and Europe next year.
In such a climate of economic growth, expected continuation of relaxed monetary policy and a pick-up of M&A activity, equity investors are in for a scenario similar to last year, when well-diversified portofolios yielded an above-average return of 5 to 15%.
According to Doeswijk, the outlook for cyclical sectors – such as infrastructure, natural resources and durable consumer goods – is especially bright. "They always perform well in the bottom phase of a recession and in the first recovery period. Moreover, these sectors are benefiting from the burgeoning middle classes in emerging markets. The demand for consumer goods like cars and computers is on the rise. In addition, increasing wealth adds to more corporate investment and infrastructure projects, such as roads, rail connections and airports."
According to Robeco the outlook for real estate is comparable to that of equities: returns will be good, but not spectacular. This sector benefits from low bond yields and declining spreads when loans are refinanced. Expected earnings growth has lagged equities for several quarters now. However, with prices remaining unchanged and fundamentals improving, the sector will probably catch up soon.
Corporate bonds performed well last year, in both the investment-grade and the high-yield segments. Doeswijk expects this to continue, especially versus government bonds.
Robeco expects the valuation of credits to remain attractive, since yield spreads hardly changed last year. Besides, corporate balance sheets are strong, earnings margins are high and the number of bankruptcies will remain stable provided economic growth remains moderate.
The outlook for government bonds is less favorable versus corporate bonds. Doeswijk considers the solvency situation of a number of European countries to be a threat. "This may be a problem when they want to refinance their debts next year. An example is Spain. This country has to refinance one fifth of its debt in 2011. If it is impossble to refinance at an affordable rate of interest, the ECB will have to step in or more countries will fall into the stretched safety net."
The ECB is not very accommodating in this respect, finds Doeswijk. "Still, when the worst comes to the worst, it will spring into action, because the perspective of failing countries is not very alluring. This will force European banks to make huge write-offs, with the ECB having to come to the rescue anyway. All in all, the year 2011 will be a year of simply trying to keep the holes plugged."
Summary of Outlook 2011
Moderate economic growth
- Fairly favorable equity climate
- Good year for cyclical sectors
- Real estate: results good, but not spectacular
- Very good prospects for corporate bonds; outperforming government paper
- Rising commodity prices
- Emerging markets continue to excel, but at a slower pace