Spearpoint Investment Strategy for 2010 from John Daley

Spearpoint Investment Strategy for 2010 from John Daley

In general our core economic outlook for 2010 is quite positive: progressive global growth with modest inflation and a benign G7 (the group of 7 leading industrial nations) interest rate environment. This should remain supportive for risk assets.

However, although the global economic recovery is developing fast, it remains unstable and may not progress at the rate many expect, particularly in the UK where the potential surprise for 2010 is that the UK becomes the first major economy to experience a full-blown debt crisis. Given the rapidly rising fiscal deficit and public sector debt ratios, a downgrade of the UK’s AAA debt rating cannot be ruled out. These risks would grow in the event of a hung parliament. For these reasons, we believe that Sterling will continue to depreciate on foreign exchange markets (there could even be a Sterling crisis) and gilt yields may have to rise (i.e. bond prices fall). However, this is not necessarily bad for UK equities as further Sterling weakness would help stimulate growth and approximately 65% of FTSE companies’ earnings come from overseas .

Global market leadership will likely change as the year progresses and individual stock selection will become more critical to the success of any investment strategy. This year’s winners have been global reflationary beneficiaries, such as emerging markets, commodities and related assets. We believe that emerging markets are susceptible to a strengthening Dollar and vulnerable to a pullback or a period of relative underperformance. They are no longer as clearly undervalued as they were, and policy makers in many of these countries will likely lead the tightening process. However, we still believe that emerging markets are in a long term bull market which will last for years to come. Investors should ensure exposure to these regions is at a sensible level.

Our base view is that the cyclical bull market in equities remains intact, but the reflation theme is currently being tested, partly because of the more uncertain outlook and partly on the back of a recent trend which has seen a strengthening US Dollar. A weaker Dollar has played a very important role in the economic recovery to-date as it has helped stimulate US (and emerging market) activity, boosted commodity prices, fattened corporate profits and therefore supported US and global stocks. A strengthening Dollar, if sustained, is effectively a policy tightening and risks a reversal or slowing of these trends that could halt the US recovery and re-introduce deflationary trends into the global economy.

The outlook for commodities will primarily be driven by the direction of the Dollar and the developing economic recovery. Those commodities that are sensitive to global business activity (i.e. oil) will likely outperform as the world economy picks up strength. Gold, on the other hand, may struggle if the Dollar sustains its recovery and as policy is tightened.

As we move into the second half of next year, markets, policy makers and investors may all become worried about the economic recovery either being too strong or too weak. If the former, this will create an intense clash between reflation assets and monetary policy, which could threaten the cyclical bull market in stocks. If the latter, the implied threat of a double-dip and renewed deflationary concerns would also be bearish for stocks.

All of these issues suggest that the policy environment will become extremely complicated and perhaps dangerous as we move into 2010. We hope that there is no major policy disaster that derails the global recovery process but nobody can be certain that this will be the case, especially as there does not appear to be a co-ordinated solution to today’s complex problems. Financial markets could, thus, experience a period of erratic movement and heightened volatility as policy makers try to steer the world economy though an increasingly challenging and difficult environment whilst investors attempt to make sense of it all.

In conclusion, we expect to be reducing exposure to risk assets if markets continue an upward trend. However, we expect the global economic recovery to eventually maintain traction and we shall use any significant setback as a reinvestment opportunity as this should lead to a new phase of the equity bull market as global stocks are driven higher by a more sustainable recovery in corporate profits and a systematic improvement in economic structure. Investors should therefore remain flexible and be prepared to react swiftly to market changes as the year progresses.