The global investment strategy team at RBS Coutts, the private banking arm of the Royal Bank of Scotland Group with offices in Dubai, Abu Dhabi and Doha, has today published its 2011 Mid-Year Investment Outlook, highlighting the key drivers of investment returns for the remainder of 2011.
"There are two big questions still hanging over the capital markets, which have the potential to disrupt the global economic recovery if left unanswered - how to refinance insolvent European countries without creating another pan-European banking crisis and what to do about the US fiscal deficit," said Gayle Schumacher, RBS Coutts' Global Co-Chief Investment Officer. "Neither is easily solved, so it is important to remain vigilant and keep our investment decision-making anchored on valuations and risk management."
Over the next 12 months, with inflation expected to continue rising, RBS Coutts predicts that high- yield bonds will be better placed than government or investment-grade bonds to provide a positive absolute return. However, equities are likely to generate better overall returns than fixed income, particularly emerging equities. Prime and industrial UK commercial property will also deliver attractive returns in a low-yield environment.
The RBS Coutts 2011 Mid-Year Investment Outlook focuses on a number of investment themes as follows:
1. Stagflation
In the west, stagflation remains a concern and investors must continue to act with caution. Inflation is currently used by most Western governments in helping to manage debt and is viewed as being much safer than deflation.
Negative real yields, combined with artificially low bond yields, are often part of the solution governments pursue to reduce overwhelming debt burdens. It is a covert way for a government to 'default' on its obligations to the domestic holders of its debt and is often combined with regulatory incentives that compel institutions to hold government debt when it makes no economic sense to do so.
Carl Astorri, Global Head of Economics and Asset Strategy comments: "A deficit reduction programme aided by 3-4 % inflation is a more achievable fiscal adjustment route than the alternative that is currently being forced on peripheral Europe - nominal public sector wage cuts (which in Greece are close to 20%) and recession."
2. Currency Depreciation
This is another route used by governments to help ease the way out of overwhelming debt. Overseas bond holders take an additional foreign exchange loss and the economy benefits from improved export competitiveness. While the US cannot agree on a deficit reduction plan, there are no voices standing in the way of a steady fall in the dollar. However, for Europe's periphery there is no currency to devalue and no benign inflation, which leaves all parties still looking for an elegant way to manage the pain of a much less covert 'default'.
3. Global Recovery: Asia leading the pack
RBS Coutts expects the global recovery to remain centred on China, wider Asia and emerging markets in general, where it is believed inflation will peak later this year. Asian markets continue to trade at a valuation discount to other countries, despite having faster-growing economies and higher returns on equity. The anticipated strengthening of local currencies is an additional source of potential returns.
4. Outlook: equities and prime property rule
RBS Coutts expects 2011 to be another positive year for risk assets but a repeat performance of 2010, with high single or double digit returns from most asset classes, is unlikely. In developed equity markets RBS Coutts predicts yield and value to outperform growth, and equities are likely to offer greater protection for returns than fixed income. Other highlights are that prime UK property will also be prized for its secure income stream and slow growth in developed economies will heighten the attractions of emerging-market equities and currencies.
"With global recovery still underwritten by loose monetary policy, cheap money still has to find a home somewhere," concluded Schumacher. "Investors should be vigilant for any bubbles, and we believe it would be a mistake to assume a smooth ride ahead."
Twelve month asset class outlook:
CASH
- 3 month cash rates: In stark contrast to emerging markets, the combination of large output gaps and large fiscal deficits will limit the extent of rate rises in developed economies.
FIXED INCOME
- Government Bonds: Bond yields should rise along with inflation expectations and stronger economic data, but the rise will be limited by a surfeit of spare capacity in developed economies and low policy rates.
- Index-linked: In an environment of gradually rising inflation expectations inflation-linked bonds should outperform nominal bonds, when adjusted for duration.
- Investment-grade: Expected to outperform government bonds in a positive growth environment and as investors search for yield, but more exposed to rising inflation expectations than equities or high-yield.
- High Yield: Better placed than government or investment-grade bonds to provide a positive absolute return as inflation expectations rise and default rates remain low, due to higher absolute yield.
- Emerging-market: Emerging-market bonds offer attractive yields with a good chance of currency appreciation as well. In addition, investors are putting money back into EM bonds as a significant part of emerging-market central bank tightening has already been priced in.
EQUITIES
- Developed-market: Equities offer better return potential than fixed income, particularly in the upcoming rate tightening cycle. Barring a rise in valuations, returns will be in the high single digits and driven by earnings. This stage of the cycle favours equity as does relative valuation.
- Emerging-market: Have struggled in response to tightening monetary policy, but remain in a secular bull market driven by superior return on equity. The key potential catalysts for a reversal are relative inflation and monetary policy trends. Early signs suggest inflation is cooling and that the monetary tightening cycle is in the latter stages.
COMMODITIES
- Oil: Continued global economic recovery will drive demand and prices, led by emerging economies. While supply fears have faded, spare capacity is at very low levels.
- Gold: Gold is a hedge against geopolitical risk as well as inflation and depreciation of major currencies, though returns are likely to come under pressure from rising interest rates.
- Agriculture: A reversion to more normal harvests and weather conditions should reverse record prices, providing an opportunity to add exposure to a long-term theme driven by both global warming and rising emerging-market demand.
PROPERTY
- UK commercial: Attractive yields and a better outlook for markets should drive positive returns, particularly for Central London offices and industrial property.
-Ends-
About RBS Coutts
RBS Coutts is the international private banking arm of The Royal Bank of Scotland Group (RBS) and a sister company to Coutts & Co in the UK. RBS Coutts offers clients a broad spectrum of wealth management services. Headquartered in Zurich, Switzerland and with offices in Asia, Europe and the offshore centres of Jersey, the Isle of Man and Cayman, RBS Coutts employs over 1,100 staff in 13 locations worldwide.
For more information on RBS Coutts, please visit www.rbscoutts.com
For further information, please contact:
John Hobday, Financial Dynamics
T: +971 (0)50 464 8706
E: John.Hobday@fd.com
Maie Ahmed, Financial Dynamics
T : +971 (0)56 775 7639
E: Maie.Ahmed@fd.com
© Press Release 2011
