Barclays Wealth Blog

‘Death by PowerPoint’ is an ever-present danger at strategy roadshows. Audience participation helps keep it at bay. Recently I’ve asked for a show of hands on two questions. The first is: ‘Who thinks the global economy is in great shape?’ The rolling 12-month response is approximately nobody. The second: ‘Can you name a time when the material conditions of life for the average person on the planet were significantly better than today?’ Here too the response is negligible.

The point this illustrates is the importance of context and perspective in the investment debate. Everyone is aware that in some sense the global economy is troubled. At the same time, they are also aware that in an underlying sense (say the ability to shelter, feed and clothe the average human) it’s really doing rather well.

Investors are currently focused almost exclusively on growth, and the news here has of course been poor. In the fourth quarter for example, UK GDP fell by 0.2%, and we estimate Eurozone GDP fell by a similar amount. Even the US economy grew in all of 2011 by only 1.7%. But the level of economic activity is overlooked, and the average standard of living is likely still very close to an all-time high.

Sometimes the differing perspectives become very visible – a good example isJapan. First time visitors arrive having read about Japan’s ‘lost decade(s)’ of growth, and its large budget deficit. What they find are startlingly high levels of efficiency, infrastructure and all-round material well-being (to say nothing of general civility).

But if the focus on short-term growth rates becomes too intense, some asset prices can diverge a long way from those warranted by the underlying level of (say) corporate profits or solvency. To some extent, this is what we think has happened of late. The divergence may represent a longer-term opportunity: at some stage those levels may start to exert a gravitational pull back towards more appropriate valuations (though Japan is not our favourite investment currently).

Actually, even the growth debate may be taking on a less negative tone. Some important forward-looking indicators in the big developed economies have been drifting higher in the last three months. This week, we saw key manufacturing surveys in the UKand even Continental Europe beat expectations. If next week’s US ISM new orders index were simply to maintain its prior level, our composite ‘G3’ manufacturing indicator would rebound to the highest level since April 2011 – a quarter of a standard deviation above its long-term average.

Meanwhile, in response to the ECB’s massive intervention, the euro crisis – which is largely and understandably responsible for that short-term, incremental focus – may be (as we thought it would) showing signs of stabilising. The interbank spread has drifted back down to levels not seen since October while Italian, Spanish and Irish 10-year benchmark bonds are flirting positively with 6%, 5% and 7% yields respectively.

Renewed volatility is still likely. Another EU summit looms, with Greece, and perhaps Portugal, still capable of disappointing. Tensions remain in the Gulf, and the political situation in France is sparking investor questions. But the positive start to 2012 by risk assets is not without foundation, and we continue to recommend that long-term balanced portfolios hold more risk assets and fewer government bonds than usual.  

Kevin Gardiner, Head of Investment Strategy EMEA

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“It ain’t what you don’t know that gets you into trouble.  It’s what you know for sure that just ain’t so. ”     

Mark Twain

This week for a change I sat through two strategy presentations myself (yes, I felt your pain). It’s important to know when we’re out on a limb, and I wanted to hear the views of two widely respected – but very different – external teams. Are we missing something?

The first was one of the largest events in the London investment calendar, hosted by a sell-side firm whose strategy team have long been one of the biggest bears in town. Our view is (we think) a constructive one – we see the European banking system and the global economy remaining firmly intact in 2012, and think this is a brighter outlook than that which has been priced in to stock markets recently. Their chief strategist has long been arguing very publicly that the S&P500 is likely to lose two-thirds of its value, and I thought I should check again to see why we differ so much.

There was more to agree with than I’d expected. Much of the talk focused on the idea that we – and policymakers, and media commentators – simply know much less about the way that economies and markets work than we realise. We’ve often warned against overconfidence in this respect in these pages, and have noted how much received wisdom – for example, the idea that the world can be collectively indebted – turns out to be not quite what it seems. They were particularly hard on central bankers, which was entertaining, but an easy – and perhaps mistaken – target.

However, in terms of their reasons for forecasting such a downbeat outcome, there were no killer charts or new data: it came down to a judgement call on whether the US and global economies were likely to disappoint sharply or not. They see the economic news as being bad and likely to get much worse, whereas we and our colleagues at Barclays Capital see it stabilising. And they see the famous 140-year “Cyclically-Adjusted” PE chart as evidence of expensive equities, while we see it as illustrating the difficulty of getting good data.

The second strategist we saw was a key fund manager at one of the biggest institutional investment (buy-side) firms in the world. He was also pretty frank about just how difficult it can be to know why markets gyrate as they do – he made the point a bit less provocatively – but his conclusions were much closer to our own. He even used the phrase “muddle through” – completely unprompted. A specific point he made that’s worth repeating is that stock analysts are likely too optimistic about profits growth in 2012, but this needn’t in itself prevent markets rallying: implicitly, the market is already pricing-in an even worse outcome. Again, we agree.

Neither our disagreement with the former strategy team, nor our agreement with the latter, makes us any more likely to be right about 2012 (though at least if we’re wrong we’ll be in good company). But we did take some modest reassurance from the fact that we are at least all facing the same “unknown unknowns”.

Kevin Gardiner, Head of Global Investment Strategy

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“It is a tale told by an idiot, full of sound and fury, signifying nothing…” Macbeth

Alas, the calendar doesn’t change the investment outlook. Frustration and confusion about the pace of euro area fiscal integration persists; economic growth is uncertain; and investors have little risk appetite, and are deeply sceptical of financial markets and financial analysis. After a volatile year it may feel to many private investors in particular as if that analysis has fallen prey to what our behavioural finance team call the “narrative fallacy” – seeing order and meaning where in reality there is simply chaos and randomness (Shakespeare said it better).

Economists do have a tendency to over-analyse and over-complicate things. Not only do we collectively know less than we think we do about the way the economy and markets work, but there may be less to be known about these things to begin with than we admit.

But to conclude that our industry’s short-term analytical and predictive hubris means that all is sound and fury would be too nihilistic. Eventually, subjectivity is tempered by more objective forces – inventories run down, technology evolves, policies change, valuations reach asymptotic levels – and basic economic forces engage and drive an underlying story forwards, however erratic and thin the plot.

So we start 2012, in our January Compass, focusing not on trying to make sense of short-term noise but instead on the longer-term implications for portfolios in a scenario in which the euro area and its banks, and the global economy, face neither disaster nor triumph, but something in between. In our view, this is still the most likely outcome.

We present there revised strategic asset allocations that suggest a bigger share of long-term portfolios for stocks, and a smaller one for bonds (echoing our recent tactical views). We note how the economy is more important than sovereign creditworthiness in setting the level of long-term interest rates, and we contrast the apparent solidity of corporate finances with more fragile stock market valuations.

Key supports for our view are the ECB’s massive and innovative actions at the short end of the yield curve, which have the potential to materially improve euro area bank funding and profitability, and more resilience in the US economy (echoed in today’s labour market data). Short-term threats include a possible downgrade for France, and unresolved Greek PSI.

Kevin Gardiner, Head of Global Investment Strategy

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