Investment Outlook - August 2013

INVESTMENT REVIEW

More positive momentum

Fears of Federal Reserve tightening and slower economic growth receded in July after two months of nervousness, with many equity markets producing strong rallies to claw back their earlier losses, despite bond yields resetting at higher levels.

US

While speculation about the Federal Reserve's timetable for tapering its quantitative easing (QE) programme continues to provide the most important focus for investors, away from the noise US equities have resumed their rally, with the S&P 500 index breaking through to new highs in mid-July, reversing all the losses of the previous few weeks. Although the picture painted by recent macroeconomic data has been mixed, second quarter GDP came in better than expected, suggesting an economy growing at an annualised rate of 1.7%. The figure will no doubt give the Fed food for thought as it debates the timing of its next move. Chairman Ben Bernanke has reiterated the official line that there is no pre-determined course for slowing the pace of QE. It will be dependent on the economic data. Should labour market conditions improve on a consistent trajectory, we expect the Fed to begin tapering its asset purchases in the fourth quarter. Treasury yields have continued to back up by almost 30% since Mr Bernanke's speech on 22 May and now yield significantly more than either UK gilts or German bunds. If the Fed eases its foot off the pedal, Treasury yields could well drift gradually higher. Mr Bernanke has been at pains however to emphasise that scaling back QE should not be seen as a tightening of monetary policy, insisting that a rate hike is highly unlikely until at least mid 2015. With inflation remaining below the Fed's target level, and economic growth still nowhere near pre-crisis levels, monetary policy will remain accommodative.

Although some uncertainty remains, for now at least much of the dust appears to have settled and US equities have gone from strength to strength, even in the face of rising bond yields, with the S&P 500 delivering around a 20% total return year to date. The sharp sell-off in bonds in May and June has finally prompted some significant flows out of bond funds and into equities. Our view is that investors still need to focus carefully on company fundamentals in assessing the scope for further gains after such a strong first half showing. With more than half the S&P 500 companies having reported second quarter earnings, most sectors have...