Macro outlook - 9 June 2010

11-06-2010

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

Investors have become more wary

Highlights

  • The ongoing—and probably worsening—European debt crisis and its implications for the financial sector are rightly worrying investors. As a consequence, deflationary risks for the world economy have increased. Central banks in the developed world are therefore likely to keep rates low for longer. The tightening process in key emerging markets is set to be less aggressive. Growth momentum in 2011 will probably slow somewhat vis-à-vis 2010.

  • The increasing pile of government debt is increasing the risk of both deflation and inflation. Our baseline scenario remains that economic growth and deficit reduction will generally reduce the excessive debt levels. However, the likelihood that either of the two alternative scenarios—monetary financing (inflation) and defaults/debt restructuring (deflation)—will materialize has risen.

  • Earnings are clearly on the rebound. The first quarter of 2010 saw the most surprises since IBES’s records began in 1988. Another round of earnings upgrades has just occurred. Analysts are now counting on earnings growth of 33% in the current year. We feel that leaves limited scope for positive surprises.

  • We expect equities to trade sideways in the months ahead. Stock valuations have improved, due to both earnings upgrades and a correction in stock prices. The price-to-earnings ratio based on forward looking earnings has decreased to 11.4x, which seems rather attractive from a historical perspective. But as the Shiller P/E (based on cyclically adjusted earnings) and the price-to-cash flow ratio still point to valuations being normal, we feel it is a bridge too far to label stocks as cheap.

  • The valuation gap between real estate and equities has grown further. For real estate, the forward P/E ratio is 21.3x, while stocks trade on 11.4x. With an ongoing lack of upward earnings revisions for real estate, we maintain our view that it is unlikely that the asset class will outperform stocks or other risky assets.