Market Commentary: 22 April 2011

It's been a month since the Chancellor, George Osborne, presented the 2011 budget and we reported on how it might affect you personally. Meanwhile, the UK economy received a surprise boost, last week, with the announcement that inflation (based on the Consumer Price Index) had dropped to 4% in March - less than the anticipated 4.4%.

Elsewhere, just when the global recovery was beginning to appear somewhat self-sustaining, markets were buffeted by unexpected events in the first quarter. These events i.e. the civil unrest in North Africa, and the earthquake in Japan and the ensuing nuclear crisis, remind us how quickly such risks can turn into reality, leaving investors second guessing even their strongest convictions.

These events aside, the overall macroeconomic (global) data actually points to a recovery across most major economies:

• The US economy has seen six quarters of positive growth and its real GDP has now completely recovered the losses seen during the credit crisis of 2008.
  
• The Eurozone has also grown for six quarters, although its real economic output still remains roughly 3% below its pre-recession peak.
  
• Emerging Markets, however, didn't witness a contraction in 2008, and hence are in the later stages of a business cycle where growth remains strong but signs of overheating and inflationary pressures are becoming prevalent.
  

On the whole, barring a truly pessimistic outcome of the above mentioned risk events, positive cyclical forces could dominate again in the current macroeconomic environment.

There are risks to recovery:

• The US Federal Reserve's quantitative easing (QE2) program ends in June, even as the US fiscal stimulus unwinds partially at the end of this year. This slow unwinding of stimulus programs could derail the nascent recovery in the US (unless there is a firm pick up in housing and consumer spending).
  
• The European Central Bank (ECB) in addition has recently hiked interest rates for the first time in three years, and a move towards monetary tightening also looks somewhat likely in the UK.

As the policy stimulus gets removed globally, structural risks have not yet been completely resolved.

• The consumer and financial sectors in the developed world are still reducing debt.
  
• The housing markets remain in moribund condition.Unemployment rates are still undesirably high.
  
• Western governments still need to embark on multiyear austerity programs to reduce levels of government sector debt and deficits.
  
• Finally, the ever so present risk of commodity inflation becoming entrenched in input and producer prices remain a distinct threat.

All these factors represent risks to growth in a world, where unforeseen risks and the possibility of policy mishaps remain omnipresent. And the inflation theme is gaining prominence in central bank and policymaker discussions across the world.

Stock Markets have been incredibly resilient as equity markets around the world have rebounded swiftly from the recent mid March lows. While some of the rally may be a function of excess liquidity, it may also be that markets are factoring in a more sustained economic rebound as solid earnings, healthy cash flows, mergers & acquisitions, stock buybacks and other shareholder friendly activities continue to support current valuations. Perhaps in the longer term even the unexpected ‘event risk' situations could be seen as a net positive to growth, e.g. the rebuilding of Japan, the democratisation of larger parts of the Middle East and the nuclear crisis might all add to global growth and industrial production.

The above is an extract from the Close Asset Management Investor Insight publication - Spring 2011.
Click here for the full report, including the Close Investment team's views on the outlook for inflation, interest rates, currencies and the major asset classes.