Scottish Investors Seeking Secure Yields Say Politics Top Economy in 2011
Whether divining Chinese interest rate policy, worrying about U.S. government finances or valuing Spanish bonds, strategists in Edinburgh say one thing is clear about next year: politics trump economics.
Fund managers in the Scottish capital are investing in stocks, corporate bonds and commercial property paying the biggest incomes from dividends, coupons and rents as they navigate markets they expect to be steered more by government action on monetary and fiscal policy than economic developments.
“The politicians have got to step up their game quite noticeably, or at some point in January, February, March or April there’s going to be some large issue that the markets really worry about,” Andrew Milligan, head of strategy at Standard Life Investments, said at a gathering of three investors at Bloomberg’s Edinburgh offices last week.
The People’s Bank of China raised reserve requirements on Dec. 10 for banks for a third time in five weeks to stifle inflation, while the U.S. estimates its budget deficit will exceed $1.5 trillion this year. Yields on Spanish bonds are close to their highest in eight years because of concern the country’s debt burden may mean force it to follow Greece and Ireland in needing a bailout, further hurting the euro.
“One of the unifying themes around the risks is that a lot of them are political,” said Bill Dinning, head of strategy at Aegon Asset Management. “We know the European solution is political. Politics absolutely matters in China.”
The MSCI World Index of developed stock markets is up 6.3 percent this month after falling 2.4 percent in November. This year, the index has fallen for every month it’s risen, gaining overall by 7.8 percent since the end of 2009.
The yield on 10-year Spanish bonds rose 1.52 percentage points to 5.52 percent over the past two months. The difference in yield, or spread, over equivalent German bunds has quadrupled to 256 basis points since the start of the year. The yield is less than half that of equivalent Greek debt.
“At the beginning of the year we’ll start to see some increases in volatility, primarily because of this euro zone issue that we don’t think is resolved yet,” said Mike Turner, head of strategy at Aberdeen Asset Management.
In the U.S., the White House budget office projects the federal deficit this year will exceed 10.6 percent of gross domestic product, and will remain as high as 3.9 percent of GDP in the first half of the next decade as the government tries to boost the economy.
Stimulus measures by the Federal Reserve will drive bond yields higher, according to Dinning, Milligan and Turner, who together oversee strategy for investing more than 360 billion pounds ($560 billion).
“Risk premiums are going to stay elevated in an environment where there’s a lot of uncertainty both about the structural health of the underlying economy and what the political responses are going to be to some of those challenges,” said Dinning.
China increased interest rates in October for the first time since 2007 as inflation rose to an annual rate of 4.4 percent. Since then, the central bank raised reserve requirements for lenders three times in five weeks. The nation’s inflation rate reached 5.1 percent last month, the most in more than two years, with food costs climbing 11.7 percent.
“A central bank that does three reserve requirement increases and a single interest rate increase in the last two months, I’d say it’s a central bank that’s panicking,” said Milligan. “It did not want to see what it’s seen.”
Additional steps from Chinese policy makers to curtail inflation, particularly in food prices, may prompt swings in securities prices around the world, said Turner.
“It has to be a risk because the market isn’t concerned about it at the moment,” he said. “That could get the markets upset in the global sense.”
While Dinning was more bullish on equities, all three strategists favored holding company bonds this year to benefit from the growth in earnings they expect to continue in 2011. Aegon bought stocks with larger dividends and sold bonds, sometimes from the same company, Dinning said. Turner and Milligan have been pushing more money into non-investment grade securities to get higher returns.
As this year ends, the first question is how European politicians stand behind the euro, which has weakened by more than 9 percent against the dollar this year and is the worst- performing major currency.
“We’re all expecting the coming year to be quite a good one, despite the risks we’re talking about,” said Milligan. “Having said that, 2012, 2013 and 2014 are all going to have the same problems.”
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