2009 MARKET OUTLOOKS

Ignis: 'Double-digit returns by the end of next year are entirely achievable'
Increasingly attractive valuations in the stock market contrast with poor returns available from bank deposits, says asset manager.

Last Updated: 4:40PM GMT 19 Dec 2008
IGNIS ASSET MANAGEMENT – 2009 MARKET OUTLOOKS

UK: Ralph Brook-Fox, manager, Ignis UK Focus Fund
“The UK stock market over the next three months should trough as the poor economic data continues to flood in. Earnings estimates will continue to fall, which they must do before we can be confident that expectations have fully adjusted.
“Markets are forward-looking, however, and once the recovery gets under way, I expect the UK market to perform respectably. Indeed, given increasingly attractive valuations, I believe double-digit returns by the end of next year are entirely achievable, especially given the increasingly poor returns available from bank deposits.
“Investors will need to be brave to avoid missing the boat and we are looking to start rotating into more cyclical names early next year, as defensive stock valuations appear increasingly stretched. Rate cuts and falling inflation favour a move into the consumer sector, but with no guarantee that consumers will spend and not save their money, stock selection will be key. Selectively, we believe clothing retailers will do well but are steering clear of stocks related to the housing market where the overhang of negative equity and limited credit availability will drag for some years.
“Rotating into more cyclical stocks is not an immediate priority, however, as we expect the news flow in the first quarter to be poor. There is no point getting beaten-up by the market when you know the punches are coming. The middle of that gloomy period, however, could be an opportune time to start looking at companies that will do well for the rest of the year.”

Emerging Markets: Bryan Collings, managing partner, HEXAM Capital
“We believe emerging markets will come out of the global crisis stronger than developed markets. From a global perspective emerging markets still exhibit the best fundamentals from almost every angle. Corporate health is good and balance sheets are generally robust, significantly more so than in developed markets.
“2009 will be the year in which deflation plagues the developed markets. Most of these would, in their current state, fail to meet the original Maastricht criteria for entry into the euro. Many emerging markets, in contrast, would pass the tests with relative ease. Deflation is, however, unlikely to occur in emerging markets, where we see inflation coming in around 4pc per annum over the next three years.
“Emerging markets are particularly compelling in terms of valuations. At just seven times earnings, stocks are insanely cheap and have been brutally oversold, down almost 60pc year-to-date as a whole. Given this, it is well worth remembering that the bounce in the first five days after the market hits the bottom is usually vicious and can reclaim over 40pc of previous losses. This is a distinct possibility in 2009.
“Fundamentally, the next two quarters are likely to see bearish macro and micro news, with slowing economic and earnings growth. This clearly poses a threat to any sustained equity market rallies, if only because of the bearish mood of the market. The bad news, however, has been more than priced into emerging markets and we remain positive for 2009 given current levels.”

Corporate Bonds: Chris Bowie, head of credit, Ignis Asset Management
“Investment grade credit has never been better value – ever. Forced sellers of corporate bonds have created a situation where investors can achieve comfortable double-digit yields on household names. Sainsbury’s, for instance, has a 14pc yield while investors can secure 16pc with Barclays, HBOS or RBS. Aviva is yielding 15pc and Standard Life 12pc. Even away from financials and retailers, there are yields of 10pc with the likes of Firstgroup, BT and Imperial Tobacco.
“For perspective, a typical bank account would take seven years to achieve a return equal to the annual yield you can buy on a Sainsbury’s secured bond. Equities look more attractive, with dividend yields rising sharply, but this is because capital values are plunging over earnings fears and we believe companies will be cutting dividends in 2009. The outlook for property next year is equally bad.
“Bonds are not risk-free of course and the default risk is undoubtedly higher than in recent years. Some companies will fail in 2009 but these are unlikely to include high street supermarket chains or banks with a government guarantee for the next three years. This risk is more than priced into yields already.
“Inflation is, of course, the enemy of bonds, but in the near term the risk is deflation as a result of the drop in economic activity. Deflation may be destructive to the real economy, but it is a major positive for bonds.
“Admittedly, the lack of liquidity in corporates means that it is difficult to get out of the asset class cheaply, so a corporate bond investment has to be for the long-term, at least for a year. Corporate bonds have, however, been battered to such an extent in the last 18 months that this is the best buying opportunity in several generations.”

Europe: Adrian Darley, head of European equities, Ignis Asset Management
“After an incredibly volatile 2008, it is already apparent what many of the investment issues will be for 2009. At a stock level it is clear that consensus earnings expectations are still too high for many companies. The key question for investors is not where earnings will bottom but what is already priced into company valuations.
“There is a danger that a myopic focus on how bad 2009 may be, could lead to similar mistakes made in 2003. This resulted in a focus on difficult short-term news flow and investors missing out when European equity markets subsequently rose more than 37pc in just eight months – based partly on falling interest rates. This is not to underestimate the global challenges many companies presently face. It does, however, highlight that, as in previous cycles, policy-makers are reacting fast. This time they are spending money and cutting interest rates more aggressively than ever before. The credit crunch will slow the speed at which this feeds through into economic growth, but the policy-makers’ actions will undoubtedly make a difference. There have also been recent examples of shares rising significantly on so-called bad profit warnings, which is a clear sign that investors are starting to see through the fog.
“Predicting investor behaviour will be important heading into 2009 and it appears most investors will enter the year positioned defensively, with high cash levels and overweight positions in telecoms and pharmaceuticals. Any shift in this stance could trigger aggressive sector rotation, as we saw in 2003. At this stage it makes sense to enter 2009 with a more balanced and less defensive portfolio than was appropriate in 2008. This means slowly increasing cyclical exposure through financial and industrial stocks, with individual stock selection vitally important. After such large stock market falls there are always excellent investment opportunities.”

Asia Pacific: Andrea McNee, CIO international equities, Ignis Asset Management
“The economic news coming out of Asia is deteriorating quickly and this is likely to continue into 2009. The impact of global deleveraging has only just hit Asia’s real economies and it will take time to work its way though. Many Asian governments are cutting interest rates and bringing in fiscal stimulus packages, while commodity prices are lower than they were. These are all positives for the region. There is a question mark, however, over whether consumers, in a time of rising unemployment and global uncertainty, are in the mood to spend the extra money in their pockets.
“The main risk is the corporate earnings outlook. Earnings estimates for 2009 are still too high and have further to fall, with downgrades likely to continue. This will abate at some point and there are positive signs emerging, with analysts’ forecasts becoming more consensual and volatility coming down from an extremely high level. It is also worth noting that certain firms will profit from the downturn. Much of their competition could be wiped out and there is money to be made from identifying strongly-managed businesses able to ride out the current slump. Also, for Asia, unlike the West, this is cyclical rather than structural and Asia has the fiscal muscle and healthy foreign exchange reserves to cushion the impact of a deteriorating environment.
“The key for markets in 2009 will be visibility. Once markets see clear evidence that there is an economic recovery on the way and that company earnings could rise, there is the potential for a significant rally. Calling the start of this is difficult although visibility should improve in the second half of the year. It is unlikely we have seen the bottom just yet, with the upswing in mid-December looking like a classic bear market rally. Equally, now is not the time to sell out of Asia.”

Multi-Manager View: Simon Mungall, partner, Maia Capital
“UK retail investors seeking an income in 2009 are not spoilt for choice. The Bank of England’s base rate is at 2pc and is likely to be cut further. UK equity income funds, the traditionally popular alternative for fund investors, flatter to deceive.
“UK equity income funds perform well in an environment in which equity issuers can continue to pay dividends. Last year, many investors claimed bank stocks looked good value on the basis of their dividend yields. This, however, assumed that banks would continue to be able to pay their dividends and, at some point, the price of equity in banks would rise to reflect this. In fact, the price of bank stocks was a better guide to the future than their dividends, which are, of course, at the discretion of management.
“Coupon income on conventional bonds is contractually guaranteed and failure to pay it puts the issuer in default. In the event of a default, the claims of a corporate bond investor are senior to the equity holder, meaning the bond investor gets paid first.
“Corporate bonds can provide an attractive yield in a safer part of the capital structure than equities. There is also a medium-term prospect of capital gains if and when corporate bond valuations return to par. Not only is the corporate bond market offering an attractive income, it is currently offering rates of return more commonly associated with the equity market, and importantly at a lower level of risk.
“Economic fundamentals will be undoubtedly difficult in 2009 and financing will remain scarce and expensive. Consequently corporate defaults will rise significantly and will probably continue at high levels until well into 2010. Proper issuer analysis is therefore essential to successful corporate bond investing, and even funds run by the best corporate bond managers will suffer defaults in a market of this nature. In our experience, however, the default rates of these higher quality funds have been less than a quarter of the number of defaults in the market as a whole. The message for 2009 is, therefore, to choose carefully or entrust your money to specialist managers who will do it for you and that corporate bond funds could be an attractive option for 2009.”

US: Terry Ewing and Alison Porter, co-managers, Ignis American Growth Fund
“The downturn in the US stock market has been consistent with previous bear markets, but the speed of the fall has been very different. Even during the much milder recession of 2001, the market took two years to reach a bottom. The current downturn is less than a year old.
“US equity markets traditionally fare better under a democratic administration. The economy is, however, the more important factor and President-elect Obama will come to power following one of the worst quarters of economic performance in US history. US economic growth is likely to fall to between -2pc and -4pc in the first three months of the year and, as such, earnings expectations for US companies will have to come down significantly from current levels.
“Obama has, however, already impressed Wall Street with his economic appointments and a more strategic approach to dealing with the financial crisis will engender greater confidence. His approach to foreign affairs could also restore the standing of the US abroad in the longer term, which ultimately will help the valuation of the market by reducing risk premium.
“Additionally, US policy-makers have been quick to act in the face of the downturn. They announced more stimulus packages in the last six months than the Japanese government did in the first eight years of the Japanese slowdown. Base rates are likely to be cut to 0pc – part of the US Federal Reserve’s quantitative easing that appears to know no bounds.
“Following his forthcoming stimulus package, Obama is likely to bring in direct and immediate tax cuts in addition to Roosevelt-like infrastructure building plans aimed at getting Middle America back to work. This will aid the economy in the second quarter of the year and will be an investment theme for the Ignis American Growth Fund throughout 2009, as certain companies will benefit from infrastructure development.
“Deflation will also be a theme in 2009 with certain companies well-positioned to benefit from falling prices, either because of their balance sheet strength and ability to pay significant dividends, or because lower commodity prices will shrink their cost base. Increasing consolidation in the airline, insurance and retail sectors should also benefit those companies well-positioned to take market share from competitors, and therefore profit from a stronger pricing environment due to restricted capital flows.”

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