Macro outlook - 6 januari 2010

Ronald Doeswijk and Léon Cornelissen, Senior Strategists with Robeco’s Economic and Financial Markets Analysis team, share their outlook for 2010.

The leading indicators for the OECD are pointing towards a continuing global economic recovery. The world economy thus looks set to strengthen further in the course of 2010, although total average growth is likely to remain below trend.

Slowly, though, the world is entering a more difficult phase in the recovery process, one in which the monetary and fiscal authorities will start to scale back their extraordinary emergency measures. Fortunately, the authorities prefer to err on the side of caution and are in no hurry to implement their exit strategies. It remains to be seen how strong the world economy really is when the stimulus is gradually removed.

Headline inflation is bouncing back into positive territory as a result of moderately rising commodity prices, but core inflation rates have been trending down and are set to remain subdued for the time being. Japan is our most likely deflation candidate. Inflation could become problematic in some emerging markets, especially in India and—to a lesser extent—China.

Debt dynamics are unfavorable in advanced economies. Government debt ratios will continue to rise in 2010. Doubts on the political will for meaningful fiscal adjustment could be a theme in selected government debt markets in 2010.

Although the US dollar is cheap on a fundamental basis, we expect further dollar depreciation against the euro. This is due to the dovish disposition of the Federal Reserve and financial markets’ concern that the US’s indebtedness is far worse than most other developed markets’. But we subsequently expect the dollar to rebound against the euro at around 1.60 when the global economic recovery gains a stronger footing, as the US’s indebtedness is not significantly worse than other developed markets'.

Asset class positioning
Equities are set for a decent performance in 2010. Heavily hit earnings are likely to rebound on the back of an ongoing upswing in the inventory cycle. At the same time, valuation should not hinder further gains. Some fear of a double dip remains in the market. An ongoing decline in the required risk premium should provide the stimulus for stocks to rise by an additional 5-15% in 2010.

Real estate is less attractive than equities, the closest-related asset class. The asset class has been at the center of the credit crisis and conditions are still tough. We expect equities to outperform real estate based on the prospects for earnings and current valuations.

We expect corporate bonds to outperform government bonds in 2010. Moderate economic growth is an attractive scenario for corporate bonds. The ongoing deleveraging is another positive, as it reduces the risk of default. In an environment of moderate growth, credits have the best prospects. High economic growth, however, would be favorable for high yield bonds.

In the first half of 2010, we expect low short-term interest rates to offer comfort to government bond holders. Later on, though, worries about the heavy sovereign indebtedness, higher inflation and increasing risks of demonetization could well push up government bond yields.

We currently have a neutral view on commodities. The production of several commodities is running at less than five percentage points below full capacity. Although we do not expect the current weak global growth to drive a short-term rally, a return to accelerating commodity prices is possible within a few quarters.

Investment themes for 2010
It is likely that emerging markets equities will generate further outperformance in 2010, as we expect an ongoing solid economic performance. Analysts are forecasting decent earnings growth, earnings revisions are good and valuation is still reasonable.

Equities in Europe should also maintain their above-average performance. The economic rebound in the region is occurring with less fiscal stimulus than in North America or the Pacific region. Earnings are set to grow in line with the market’s average, while the region’s valuation is relatively cheap.

Natural resources stocks have good investment prospects. As soon as full capacity returns, significant price increases are possible in order to bring demand in line with the tight supply. That would boost earnings. At this point, we do not expect valuation to hinder the sector’s outperformance.

We think IT will outperform the market in 2010. The sector has had above-average earnings revisions for several months in a row. The P/E ratio relative to the market has been falling for almost a decade and is back at pre-internet bubble levels. The introduction of Windows 7 might spur on the sector, as 80% of business PCs still run Windows XP.

In a period of economic recovery, industrials should also be an interesting investment opportunity. Infrastructure asset constructors in particular should benefit this cycle. However, it still looks too early for infrastructure to outperform the market, due to its late-cycle characteristics. But the likelihood of outperformance by infrastructure will increase as the economic cycle progresses.