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Miton - Why caution is key

As markets continue their inexorable rise, both the Dow Jones and S&P 500 have hit record highs at the start of the month, optimism still abounds.

Sadly, from an economic perspective, the global recovery is likely to remain subdued for the foreseeable future with modest and fragile growth.

Despite the recent events in Cyprus, the worst of the crisis in the Eurozone is probably yet to come as the authorities appear resolute in their determination to muddle through. The ECB’s Outright Monetary Transactions may help manage the burden of high borrowing costs, but it has not solved the underlying problems of peripheral countries, including unsustainable sovereign debt, significant lack of competitiveness and fears of redenomination. Even if Spain and Italy eventually accept a full bail-out, capital flight from these countries is likely to continue. With politicians seemingly unable to accelerate progress towards fiscal union, we expect the Eurozone to continue down a path of recession for a prolonged period.

The UK appears to have come out of its double dip recession, at least temporarily, but underlying conditions remain very weak and it is likely to stage at best a flat recovery in 2013. The coalition government is sticking to its austerity plans which, combined with the Eurozone recession, will keep demand and growth sluggish.

The US looks set to continue growing at a pedestrian pace. The positive news is that the banks are now beginning to turn the corner and appear to have started the recovery process of recapitalisation whilst the housing market is finally showing signs of life. However, weak demand and falling real household income means growth is unlikely to kick on from here and elevated unemployment is likely to persist.

The currency markets are, as they have been since the height of the financial crisis, an ugly contest. However, at this juncture it is hard to justify stronger Euro or Sterling against the Dollar. Ongoing stresses in Europe almost guarantee a policy of continued loosening – certainly any interest rate rise will not be forthcoming whilst the Eurozone remains as it is today. The economic backdrop in the UK is likely to be bleak, at best, in the short to medium term and with no obvious credit growth, domestic inflationary pressures are likely to abate. It is therefore difficult to make a case for either Europe or the UK tightening ahead of the US.

The prospects for the US Dollar will be influenced far more by the macro developments in the Eurozone than any further easing by the Federal Reserve, and it is not beyond doubt that the Dollar may witness the same strengthening against Sterling as was witnessed in 2008 if we enter a second period of significant risk aversion due to a fallout in Europe. This is perhaps more pertinent than ever before as much of the easing of QE1, 2 and 3 is now firmly baked in to the price of the Dollar.

The Federal Reserve’s pledge to keep rates at current levels was based on two factors. Firstly, that the unemployment rate remained above 6.5%, and secondly the projected inflation rate remained below 2.5%. If one of these events is triggered, it may force the hand of the Fed to adjust policy and raise rates. The inflation threshold is likely to be the one to breach first, particularly if credit continues to flow (certainly more freely than in Pan-European markets) and the housing sector continues its rebound. This may be the left-field event that triggers a rate rise ahead of target, catching Dollar bears off guard.

Expectations of more aggressive monetary easing from the Bank of Japan has weakened the yen, even though there is already little practical difference between its stance and that of the Fed. We continue to think that demand for a safe haven from the crisis in the Eurozone will keep the yen firm for the next year or two. But thereafter, the eventual normalisation of interest rates in the US and the diminishing current account surplus in Japan suggest that the yen should fall more sharply.

An escalation of the Eurozone crisis should maintain safe haven demand for the yen, at least from Japanese investors preferring to keep money at home. A partial break-up of the Euro is the basis on which we forecast the yen to strengthen again. But looking further ahead, US interest rates are likely to rise well before those in Japan. This alone could easily see the yen weaken. Europe will eventually emerge from its crisis too. And in the meantime, Japan’s current account surplus has been diminishing, with September last year actually seeing a small deficit. We therefore expect the yen to start a period of weakness once developments elsewhere are no longer so negative, albeit not yet.

The outlook is far brighter for most parts of Asia, although the more open economies, such as Hong Kong and Singapore, will be dragged down by any weakness in world trade. But in most countries domestic demand should remain fairly strong and central banks have room to loosen policy if required. In contrast to most advanced economies, there is also scope for fiscal stimulus.

The last few months have seen risk assets move in a rather different vein to that which we have become used to over the last three years or so. ‘Risk on’ correlated moves have been less prevalent as boring large-cap equities with higher yield have risen strongly, whilst emerging markets have been shunned. Prime sovereign bonds have rallied, whilst sub-investment grade have slipped back. And commodities, across the range of precious metals, industrial metals and ‘soft’ agricultural commodities, have generally had a torrid time, whilst prime property continues to shine. Central Bank liquidity is still driving asset prices higher, but it seems that an element of ‘large and (relatively?) safe’ is driving investors as they begin to wonder when the printing presses might slow.

In the light of the above, a return of around 6% for the CF Miton Special Situations Portfolio over the first quarter seems quite good, given the flattish performance last year. However, it is the longer term outlook that is our focus and nothing that has happened recently provides much room for optimism. Global growth and corporate earnings are likely to continue to disappoint and the fund remains defensively positioned accordingly.

Martin Gray - Miton, April 2013

Important notes

Please note that these are the views of Martin Gray, Manager of the CF Miton Special Situations Portfolio fund, Miton and should not be interpreted as the views of RL360.

Important information

The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment advice. Whilst Miton has used all reasonable efforts to ensure the accuracy of the information contained in this communication, it cannot guarantee the reliability, completeness or accuracy of the content. This communication provides information for professional use only.

Miton is a trading name of Miton Capital Partners Limited and Miton Asset Management Limited both of which are authorised and regulated by the Financial Conduct Authority and registered in England No. 4325961 and 1949322 respectively with their registered office at 10-14 Duke Street, Reading, Berkshire, RG1 4RU.


Martin Gray

Manager of the CF Miton Special Situations Portfolio fund
April 2013

Please note that these are the views of Martin Gray, Manager of the CF Mitons Special Situations Portfolio fund, Miton and should not be interpreted as the views of RL360.

360 fund links

The CF Miton Special Situations fund can be accessed through our guided architecture products Oracle, Paragon and Quantum, and also through our PIMS portfolio bond.