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Andrew Milligan, head of global strategy at Standard Life Investments, is a perceptive and highly-experienced analyst of financial markets. At Standard Life, he oversees strategy for one of Europe’s biggest assets managers with more than £120bn under management. He has become more cautious on the outlook for markets.
He says the slowing US economy will bring about a deceleration in global growth in 2007. “Combined with the level of financial engineering we are seeing in some parts of the credit markets, this gives good grounds for caution in the short term. However, the longer term outlook for equity markets remains positive as long as corporate profits are resilient,” he says.
Mr Milligan can answer your questions on the outlook for equity markets plus issues such as the impact of migration on markets, M&A as a driver of market performance, whether international investors should target the US or Europe, inflation, the outlook for energy stocks, where the opportunities are in Europe and which sectors to invest in and avoid.
Even if global growth slows, are we being too sanguine about inflation? Some central banks including the ECB and the Bank of England are stressing the risks from the surge in money supply. What if they are right and inflation is picking up? What should investors do to protect themselves?
Bronwyn Curtis, United Kingdom
Andrew Milligan: Inflation is the major issue which investors need to monitor, both over the next 12 months and the remainder of this business cycle. We remain bullish about inflation trends as we see the competitive influences of globalisation remaining in place, while the impact of the energy cycle looks, at long last, to be fading. We are not too concerned about money supply growth, as the relationship is far from being as close as it was some years ago.
Lending to individuals and corporates in Europe has started to respond to the ECB’s policy tightening. In the UK, headline money supply growth appears high but this is inflated by special factors affecting ‘other financial institutions’, while lending for mortgages is broadly steady. Nevertheless, you are quite correct to say that global growth does need to slow in the coming year and create some spare capacity. Otherwise, we will see wage pressures feeding though steadily into service sector and then core measures of inflation.
What is your outlook for Japanese equities over the next 12 months?
Ian Bright, UK
Andrew Milligan: We are Neutral on Japanese equities at present. Our asset allocation has favoured the more defensive equity markets, such as the US, the UK and Europe, bearing in mind the relative valuations, earnings prospects and an expected upturn in stock market volatility during 2007. There are positive arguments for holding Japanese equities in a portfolio, either because of a major upturn in the global trade cycle in late 2007, or in terms of the very accommodative monetary policy being implemented by the Bank of Japan. The structural reforms being implemented by Japanese firms have also been more widespread than many investors realise. Nevertheless, our detailed analysis of investor sentiment and positioning suggests that investors should be cautious in the short term - a lot of investors have moved into Japanese stocks and we consider that they are too early.
Do you think HSBC’s profit warning is a leading indicator of more widespread malaise in the US lending market, and higher risk which is not priced in financial sector shares?
Andrew Milligan: The simple answer is no. There will be more bad news to come of course – to quote Warren Buffet, it is only when the tide goes out that you see who has been swimming naked! We wrote about the problems facing US housing in our Global Insight publication last summer. Our conclusions were more upbeat than some, less positive than others. We envisaged continuing difficulties facing certain sectors and certain states, such as Florida and California, but it is the case that the underlying mortgage market remains well supported by some positive fundamentals such as demographics and net housing wealth.
Looking at the stock market implications, we do not see the recent difficulties which are affecting the sub-prime part of the US housing market as indicating more dangerous concerns across the whole financial sector, but more pain will clearly be felt by certain firms.
Gold is at its highest since May last year $666 an ounce, but does the number of the beast mark a tipping point or a reason to buy in?
Geoffrey Butler, London
Andrew Milligan: As you are looking to the Book of Revelations for guidance on investments, may I tell you a story about two university friends who met one day after many years. One was clearly much wealthier than the other. The less successful one asked, “How has everything been going with you?” His friend replied “Well, one day I opened the Bible at random, and dropped my finger on a word and it was oil. So, I invested in oil, and boy, did the oil wells gush. Then another day I dropped my finger on another word and it was gold. So, I invested in gold and those mines really produced. Now, I’m as rich as Rockefeller.” His friend was so impressed that he rushed to his hotel, grabbed a Gideon Bible, flipped it open, and dropped his finger on a page. He opened his eyes and his finger rested on the words, “Chapter Eleven.”
I hope you enjoy the joke! My view on gold is simple: I do not like holding an asset that does not give me a yield. In day to day terms, inflation proofed bonds / index linked gilts have replaced the usefulness of holding gold in a portfolio in a normal low inflation environment. If you consider that the financial markets face a sustained period of significant deflation or high levels of inflation, then gold has a place in your portfolio as it does help protect against such major shocks - but they do have to be major.
Commodity stock funds have been hit by oil’s fall from its highs of last year. Will weaker global growth prevent a recovery in commodity funds or will speculative action buoy them?
William Wilson, London
Tin prices are high for the current cycle, can it last?
Tom Griggs, London
Andrew Milligan: Your questions neatly bring out the two main drivers of commodities, the underlying supply and demand dynamics and the recent capital inflows. Starting with the former, I would argue that it is vital to look at commodities on an individual basis. Last year, there were large price movements for some of the metals and softs, but by no means all of the CRB components performed well. Flows are important, as too many retail and institutional investors have been indiscriminate when buying commodity funds. These flows have materially altered the dynamics and hence the rewards of the market; hence the total returns from investing in such funds were usually negative in 2006. Our view is to be wary of investing in commodities wholesale; we do see suitable opportunities for individual commodities, and hence our equity teams have significant holdings in a number of the resource stocks.
Do you think that the US Home builder’s stocks have already reached rock bottom?
Jorge Grinberg, CFA, Montreal, Canada
Andrew Milligan: Our US equity team remains concerned about the negative environment for the US home builders and is very selective indeed in its holdings. The recent fall of about 10 per cent in the share prices of these stocks, and the negative earnings outlook from some of the larger companies, should remind investors that the outlook into 2007 is by no means as positive as some commentators have tried to make out.
Andrew, I share your view that the outlook for equity markets remains positive as long as corporate profits are resilient. I don’t see any particular threats to global GDP growth, however there is an article in today’s FT that reads The percentage of US companies failing to meet Wall St earnings expectations has reached the highest level in more than two years. Is this discounted at all in equity markets at the moment?
Greg Cheverall, London
Andrew Milligan: One of the key questions in our Focus on Change methodology is ‘What is priced into the markets?’. On our analysis, a lot of the bad news about US profits has already been discounted, but not all. Recent US profits growth has appeared strong in the third and fourth quarters but this was partly boosted by special factors affecting the insurance sector.
Underlying profits growth looks set to be 5-7 per cent a year for the fourth quarter, and analysts have been downgrading expectations for the first half of 2007 towards 3-5% a year. We still see some risks to the downside as we do not see the full impact of the inventory cycle and the housing cycle fully present in the economy. Our research shows the major importance of earnings growth remaining positive in 2007, as a period of negative earnings has traditionally caused major concerns for investors. For more analysis on this issue, please see the Overview article to the spring edition of Global Outlook on our web site.
What is your outlook for the US bond market? Will economic growth slow enough to support US Treasuries? If not for how long can the US Treasury yield curve remain below the Fed funds rate?
Tony Tassell, London
Andrew Milligan: We are positive on the outlook for US bonds. We do think that economic activity was boosted over the winter by special factors, especially the mild winter weather and lower energy costs, while the inventory cycle and the continued pressures on the housing market, as exemplified by last week’s news from sub-prime lenders, will cause the economy to slow again into the summer.
A reappraisal of the inflation outlook will start to be seen in the US, which will be supportive for Treasuries. Your more important question is actually the second part about the shape of the yield curve. I am not concerned about an inversion of the curve, and do not regard it as a particularly useful director of future activity. I see the longer end of yield curves in the US and other countries as affected by the investment decisions of a group of investors who are not buying bonds for profit but due to regulatory decisions.
Reading through White House spin, what is the truth regarding the enormous accumulation of the US total national debt? I’ve read frivolous responses such as it’s only x per cent of out GDP. If is is worrisome issue, what can the average citizen do to voice his or her concern? Who should that concern be directed to?
James Dion, US
Andrew Milligan: I assume you are talking about government debt. On an annual basis the US is running a federal government deficit of about 1.5-2.0 per cent of GDP, which is no worse than most other major economies and better than many. Europe is running deficits of about 2 per cent, in the UK it is closer to 3 per cent on some measures. In terms of the national public debt which has built up it is about 37 per cent of GDP which is below the OECD average of the other large economies, more like 40-50 per cent for many).
Servicing such debt is entirely practicable, as long as inflation and therefore interest rates remain about current levels. There are issues in about 20 years time due to demographic trends, especially the impact of an ageing population on medical care costs, which politicians need to address in the coming decade in the US, and indeed in other countries too. My colleague Richard Batty wrote about ‘the impact of healthy wealthy retirees’ in our spring Global Outlook on the SLI web site. Please have a look at that
Is the City and its wealth really doing enough for society in terms of making the UK a more equal place? Do business leaders do enough to help society?
Rachel Gibson, London
Andrew Milligan: It is easy to castigate the ‘City’, but let us define the term a little more precisely. Who are the largest investors in the City? Answer – pension funds and insurance companies, investing on behalf of their clients, and trying to meet their needs in terms of important matters like ‘what sort of house can I live in’, ‘how well off will I be in retirement’, ‘where can I go on that silver wedding anniversary holiday’. I would put your important question in another way: what is the role of the financial services sector in a modern society? Strategists and economists have a role in answering this, as do politicians and even theologians!
With an ever increasing world population and ever decreasing natural resources -- it seems inevitable that the GDP model is outdated. Can growth not be measured in any other context than increased financial profits?Bhutan - small and backward though it may be - has long since initiated a Gross National Happiness model that is more than interesting to most new students in economics. Thank you for your time and any insights you might have to offer.
Russ Crone, Sweden
Andrew Milligan: Economists have long recognised the dangers that you point out. We all use GDP as a proxy for ‘utility’ but it is by no means a perfect alternative. Externalities are easier to outline in theory than they are to measure in practice. There are already a number of developments, both amongst academics and amongst government statisticians in Continental Europe, the UK and Canada. I would not agree that the GDP model is entirely out-dated but I would agree that it must evolve in coming years.
Do you agree that liquified coal and biodiesels in their cleaner versions will become the driver of a new push towards diesel vehicles around the world? When do you see this push taking hold and benefiting the stocks of car mfgs/coal/and related products?
Avi Mairowitz, New York
Andrew Milligan: I cannot pretend to be an expert on this particular technology. I would say that we are considering a variety of environmental issues on the Strategy team at Standard Life Investments. I would point you towards our Annual publication Global Horizons, which you will find on our web site, and within that the article on Investing in the environment written by my colleague Frances Hudson.
To quote the article: “There is no doubt that the high cost of conventional fuels has played an important part in fostering investment in alternative energy. The IEA claims that biofuels become increasingly competitive at crude oil prices above $60 per barrel”. In general though we are concerned that while a number of alternative energy sources are favoured from an environmental stance, firstly there can be countervailing environmental issues which need to be taken into account, eg desertification say for biofuels, and secondly they do vary significantly in their ability to meet demand on a competitive cost basis.
Pension wise - would you say this is the time to invest in opportunities funds?
Y Penny, London
Andrew Milligan: My initial advice would be that such a title as ‘ opportunities funds’ can cover a wide variety of investment vehicles, so look carefully at the details to see what it covers. In general, yes, fund managers are developing their high alpha vehicles to take advantage of market inefficiencies and these can form a small part of a diversified pensions portfolio. Our firm has a number of offerings in this area, which I hope you would look at!
How do you protect your portfolio from the worst case scenario? What is the worst case scenario?
Andrew Milligan: Each investor will have a different worst case scenario, depending on their current level of assets and liabilities, as well as the risks and time scales involved. An equity bear market is bad news for someone who is fully invested in risky stocks, but very good news for someone with cash to invest. A sharp rise in bond yields would be worrying for governments with high debt levels but good news for someone about to take out an annuity. If there was one scenario that we are worried about though it would be a fundamental deterioration in inflation. Put simply, the UK has been a low inflation economy since 1993, which has caused a fundamental re-pricing of UK financial assets. Losing control of inflation would cause a major reappraisal about the outlook for the investment cycle.
Is it possible that slowing of the US economy could in fact quicken global growth in 2007? The reasoning behind this is that, other developing economies could exploit America’s strengths and expand even faster.
Kunal Amin, United Kingdom
Andrew Milligan: I would make several points in answer to this question. Firstly the relationship between the US and the rest of the global economy has become much more complicated than many investors realise. Economic activity in the States is important but it is by no means as dominant as it was say a decade ago. Indeed, on some measures US GDP is only about one quarter to one third of the global total.
Secondly, obviously a recession in the US would have a major impact elsewhere, through trade and capital linkages, but a slowdown in North America can be offset by continued expansion amongst other major trading blocs, such as Europe and Asia. In 2006 we saw a more balanced world economy, as weakness in some areas has been offset by strength in others, and we expect this trend to continue into 2007.