Worldwide fixed income and equity markets in 2002 will be most significantly affected by a return of the global economy to real growth. While the ongoing war against terrorism will continue to contribute to a general level of uncertainty in all financial markets, the rebound in US equities since the events of September 11 suggests that terrorism will influence markets, but not dominate them.
In historical terms, the fiscal and monetary policy responses adopted by most of the industrial nations have been uniquely aggressive, and, we believe, will show positive results during the current calendar year.
However, it is worth noting that there are a number of economic ‘headwinds’ to growth in the US that will affect the timing and magnitude of the upturn. For example, the balance sheets of companies and consumers are stretched, and corporate profits are likely to be under continuing pressure.
Nevertheless, the tremendous liquidity which has been provided by the US Federal Reserve and, to a lesser extent, the European Central Bank, is likely to flow substantially into corporate, high-yield and emerging market bonds and equities.
While returns in the fixed income markets are unlikely to go back to the levels of the past two years, we do anticipate that segments of the bond market, such as corporate bonds and high-yield/high-risk instruments, including emerging market bonds, will offer opportunities.
When considering an investment in corporate bonds, we urge great selectivity, as there is still the potential for entities with weaker credit to be pushed over the edge. The collapse of the US utility trading giant, Enron, gives sound grounds for caution. The key, as always, is to look carefully at the creditworthiness of the issuer.
While emerging markets continue to be risky, they don’t seem to be as closely linked as they were in previous crises, such as the cascading effect of the August 1998 Russian default. For example, Argentina’s debt crisis does not appear to be having a similar impact on Latin American economies. From a credit point of view, there are still positive stories in Latin America, such as Mexico and Brazil, where credit is improving and bonds are performing quite well.
The US will probably return to serve as the global growth engine, although as discussed, the power and speed of this engine is still an open question. Europe will improve, although with a lag of several months.
If interested in investing in Europe, we suggest looking at Russia and the Ukraine. We also believe that Euro-denominated bonds might do relatively well, compared to US and Japanese issues in 2002. The Japanese economy, as it looks at the moment, will continue to deteriorate. From a bond perspective, opportunities in Asia in 2002 will generally be rather narrow in scope.
On the equity side, we find small caps an attractive opportunity. For instance, of the 200 European stocks that we follow with a capitalisation of less than US$2 billion, the average price earnings ratio late in 2001 was less than 10. Elements are in place that could make for a powerful rally in these markets, and price earnings ratios suggest opportunities in European small caps.
The 50 per cent rally in tech stocks in the US that we have seen since September 11, has already been priced into the recovery of equities. Accordingly, we suggest not making wholesale shifts toward technology but buying only those tech stocks that make sense from a valuation point of view. Further, we see healthcare and biotech as areas where science-based industries are making quantum developmental leaps.
Also, if the economy rebounds, the past has shown that media companies outperform the market, as advertising spending tends to disproportionately rise.
Far from doom and gloom, we see 2002 as a year of opportunity for the thoughtful and careful investor, as the global economy shakes off the shocks of 2000 and 2001.
— Remi Browne is chief investment officer of international equities at Standish Mellon Asset Management, and William Cook is the Boston-based manager’s head of global fixed income.
