Panellists boosted exposure to America - where the economic figures have improved - and eschewed Britain and Europe, which are suffering from weak growth and fiscal retrenchment.
America is in the midst of a growing dilemma, with antagonists on both sides of the debate hunkered down and launching salvo after salvo of vitriol at one another.
The principal cause of this disharmony is a profound disagreement on the causes of the financial crisis and through this how best to model current government policy to prevent a slump back into recession.
In the “liberal” camp are Paul Krugman, the Nobel-winning economist and New York Times columnist, and Brad DeLong, professor of economics at the University of California, Berkeley and previously deputy assistant secretary of the American Treasury. They argue that the financial crisis was a liquidity crisis and that fiscal retrenchment while growth in western economies remains weak and unemployment is rising, could cause protracted economic stagnation. As such stimulus spending should be extended rather than reduced to keep sufficient liquidity in the market.
The other side of the debate consists largely of a disparate grouping of Jeffrey Sachs, an American economist and director of the Earth Institute at Columbia University, and Raghuram Rajan, professor of finance at the Booth School of Business in the University of Chicago. They are joined in Europe by, among others, Axel Weber, president of the Deutsche Bundesbank, Jean-Claude Trichet, president of the European Central Bank, and Mohamed El-Erian, the chief executive of Pimco, in calling for urgent austerity measures in highly indebted countries so that they can avoid a Greece-like fiscal crisis.
While this debate rages investors have begun making up their own mind on the country. Adviser Fund Index (AFI) panellists mimicked the findings of the Bank of America (BoA) Merrill Lynch fund manager survey as they bought back into America during the May rebalancing at the expense of Britain and continental Europe.
"To an extent it’s a trend that we’ve been part of for some time,” says Tim Cockerill, the head of research at Ashcourt Rowan. “We went overweight America more than six months ago and took money out of Europe. What we thought we saw was improving economic figures and good corporate earnings.”
Cockerill’s belief that America was starting to look good value compared with a battered eurozone and harsh spending cuts promised by the new British government, was one shared by many investors as 2010 continued. In May’s fund manager survey a net 22% of asset allocators were overweight in the country and Gary Baker, the head of European equity strategy at BofA Merrill Lynch Global Research, called it “the region of choice”.
Optimism, however, took a knock last month as employment figures out of the country showed private sector job growth had slowed in May. Over the month America’s private sector grew by 41,000, falling from 218,000 positions created over the previous month. Markets reacted poorly to the news with the S&P 500 falling 3.4% following the announcement.
“We’re still concerned about cyclical stocks so we’ve got a bias to utilities and healthcare and an underweight in retailers and financials,” says Graham Toone, the head of investment research at AFH Wealth Management.
In these conditions cutting government spending and restricting liquidity is something of a risk. The problem is that governments are chasing an intangible and wholly subjective goal in cutting spending to reassure bond markets and retain, or in some cases regain, fiscal credibility internationally. The risk they take is that, as with Greece, bond markets might remain unconvinced by the actions while cuts in spending and rising unemployment reduce domestic consumption by causing people to hoard cash.
“What concerns me about Britain is that if we cut spending and raise taxes, we could fall back into recession,” says Keith Wade, the chief economist at Schroders. “In the past falling deficits have occurred when interest rates are falling and the economy is growing, which is obviously not the case. It may be that we don’t get the full amount of fiscal cuts that have been announced.”
Despite concerns over the possibility of similar austerity measures on the other side of the Atlantic, Wade agrees with Cockerill that the earnings picture for America remains better than for its European competitors. This combined with the fact that the dollar remains the world’s reserve currency has helped dampen fears of a double-dip recession.
Strange though it may seem Barack Obama, the American president, might also consider thanking his predecessor as 2010 comes to a close. Between 2001 and 2003, Congress passed a series of temporary tax cuts to reinvigorate the economy but these are due to come to an end at the start of 2011. They include a reduction in child credit, an income tax rise of between 3-4.5%, along with the removal of the 10% bracket and an increase in the top rate of estate tax to 60%.
This will amount to fiscal retrenchment on the sly as although taxes will go up, it will be a product of Republican policy rather than the administration.
Cockerill says that however you look at it without a recovery in America the global recovery will falter.
“On a 12-month view I think the US is probably going to fare well. If it doesn’t I can’t see Britain and Europe doing well.”
