05/12/2007

Outlook for 2008

Successful investing in 2008 will require investors to make good calls on a wide range of issues, including liquidity, earnings, inflation, currency, and regulatory decisions, according to research published today by leading investment house, Standard Life Investments.

In the latest edition of Global Insight, its monthly investment view, Standard Life Investments examines why three inter-related issues; credit market problems, the outlook for corporate earnings, and the inflation backdrop will be vital for successful asset allocation decision making in 2008.

Andrew Milligan, Head of Global Strategy for Standard Life Investments, said:

“A number of commentators are understandably concerned about the rising tensions in money markets into year end, and beyond. The spread between official interest rates and money market rates has begun to rise back towards the alarming levels seen in the late summer, especially in the UK. The whole question of sub prime debt, and the potential losses for investors, has been much discussed during the autumn.

“Our analysis emphasises that these issues are simply parts of a wider problem: a reassessment of the pricing and availability of a whole range of credit instruments, not just in the US but globally. Into year end, more investors came round to our conclusion that the current situation is not like LTCM in 1998 but will take longer to sort out. This stems from the wide array of risk holders, the opaque nature of many of the new credit instruments, and the growing recognition of the interaction between weak housing markets and the broader economy, especially in the US and parts of Europe. Credit market de-leveraging will continue for both corporate and consumer borrowers, until an array of banks and non-bank financial institutions have brought their balance sheets back into order, for example by raising new capital, or much greater confidence returns with regard to what value to attach to such assets. All in all, a period of overly easy credit has ended.

“A second issue for investors to address is the outlook for corporate earnings. Our research strongly concludes that equity markets can hold up well in an environment of positive earnings growth, but if corporate profits actually decline then stocks can perform rather poorly. In this respect the outlook for the US economy is important. The US was slowing noticeably even before the recent credit tightening or the rise in oil prices. A major conclusion from our analysis is that investors should pay more attention to developments in Europe and Japan in 2008.

“Central bankers face a dilemma in coming months: do they focus on headline inflation or on core inflation? There was a successful reduction in inflation pressures in the first half of 2007, but in recent months inflation expectations have deteriorated once again. The cause is obvious: the rise in commodity prices, especially oil, grains, meat and dairy prices. The outlook is poor into spring 2008, with headline inflation in all the major economies likely to rise by another ½% or so.

“The key issue for equity investors in 2008 will be the direction of earnings, directly related in turn to whether the current liquidity crunch turns into a credit crunch. The consensus currently expects global profits growth of over 10% pa. We expect this figure to be downgraded significantly, bearing in mind our forecasts of below trend activity in most regions. Although company profits on a global basis look set to remain in positive territory, a combination of credit problems and uncertainty for some time to come about the economic backdrop, mean that a more difficult environment is still expected for 2008.”