Evercore Pan Asset

This year is proving to be as tough and disappointing for investors as we always feared. We are now well into August. So far this year investors in the main share markets have seen the indices drop back below their opening levels again – in the US, the UK, and the world generally. India has done a touch better, and China worse than those averages. Looking down the list of ETFs I monitor regularly, the only double figure capital returns this year so far for sterling investors have come from US property, US bonds, and emerging market bonds, thanks in part to the rise of the dollar in the first part of the year, and from gold bullion.

The good news for our portfolios has been the growing interest in recent weeks in corporate bonds. We liked the near 6% income on high grade corporate bonds at the start of 2010, and have added to positions during the year where we felt we could do with some more. So far these have produced a capital return of around 5.5%, adding a modest capital gain to the decent income. We still think they offer one of the best havens for savings this year.
 
Why have the returns on shares been so poor? After all, this is a year of economic recovery. The main economies have delivered growth. In India and China the growth has been so strong all the worries are about overheating. In the US, the UK and Germany the growth is solid if modest, but a relief after the traumas of the high Credit Crunch phase. Companies in these areas are on average generating much better profits and cashflow, and are restoring or increasing dividends.
 
The problems are different in the emerging markets from the advanced economies, in that China and India are having to raise interest rates or restrict credit to ward off worse inflation, whilst the West is still puzzling over how to get more growth out of the large stimuli they have administered. The problems are the same, in that both parts of the world economy are experiencing monetary tightness or tightening. That does not make good conditions for asset prices to move upwards strongly.
 
The great recovery in economies and share prices in 2009 owed much to the large monetary stimulus in China, and all the buying of raw materials and other imports that China needed to fuel her sharp spurt in growth. The purchases of bonds and distressed assets within the financial and banking system in the US and Europe also helped. China is now squeezing the easy credit by controls to cool the situation a bit. India remained on full monetary throttle last year and is now raising interest rates to slow things down.
 
Meanwhile, in the West, the US and UK quantitative easing programmes have been completed. The US money supply figures are giving economists plenty to argue about. Narrow money – bank notes and on demand deposits – have shot up. Broader money, including much of the money companies and individuals might spend if they had it, is still falling. Some say the former is what matters, as it will enable the banks to lend more in due course and fuel the recovery. Others, like Tim Congdon, argue that falling broader money is bad news. The banks may not be able to stoke up their lending on the back of more narrow money around, because the regulators are still demanding more cash and capital for any given amount of lending.
 
In the UK the position is slightly better, but here too the banks are under regulatory restrictions which impede the usual expansion of credit at this stage of the cycle to fuel the recovery. Meanwhile, the debate about public spending is being conducted in terms of very large cuts which are not scheduled to materialise overall but are creating fears amongst consumers and companies hoping for public sector contracts.
 
Some still think we are in for a double dip recession in the West. They predict further falls next year and expect deflation. Some fear inflation, pointing to the large amounts of cash created by quantitative easing and related policies. The economic forecasts still mainly predict a slow recovery in the West with some slowing in the East. We still recommend holding onto a balanced position, with the biggest emphasis on good quality corporate bonds. There is some protection in a 5.5% income at a time of very low yields generally.

The decision of the US authorities to reinvest proceeds from sales of mortgage securities in Treasuries is a sign that the authorities are still looking for a way of administering more stimulus without letting inflation take off. The behaviour of currencies and markets recently shows that investors want greater certainty of continued recovery, and wobble when they are not reassured.