An extract of the May 2009 edition of Investment Strategy:
The pace of deterioration is easing
Economic data released over the past few weeks is gradually confirming the belief that the economy, after collapsing in the fourth quarter of 2008 and a very rough start this year, is now deteriorating at a slower pace. In addition to the United States and China, this can now be seen in Europe and, to a lesser extent, Japan. Although economies are still contracting, there is undeniably a cyclical pick-up that investors have been applauding over the past two months. We do not totally share their optimism however. Although the worst of the recession may now be over, global economies have sunk quite low and the consequences of last fall’s severe downturn will not disappear in a few months.
The financial system is still main concern
Reactions to the publication, early this month, of the results of the stress tests of US banks have been mixed. Although there was relief to learn that they would need relatively little recapitalization there are still doubts concerning the methodology employed and the transparency of test results. What happens to toxic assets in the global financial system is therefore likely to remain a subject of concern. Indeed, the IMF’s now estimates the total losses in the US and other mature markets such as Europe at over four trillion dollars. This makes monetary policy measures less effective in getting banks back on their feet. To solve this problem and get credit flowing again, central bankers and government officials have either imposed (as in China), bypassed the banking system (as in the US), or adopted measures to strengthen banks, as the ECB has done recently. Although the first solution has been the easiest to implement, the second is beginning to show signs of working (albeit more slowly than Ben Bernanke expected) while the third approach of allowing banks to preserve their central role in the financial
system has yet to prove itself. We expect the strengthening of financing conditions to ultimately bear fruit, as suggested by the current signs that interbank markets are starting to function more normally and that credit markets are more liquid. However, this process will take time.
Fundamentals do not justify a sustained recovery in equity markets
The equity market rally observed since March 9 may continue for a few more weeks, as long-term investors who fear “missing the bounce” return to equity markets. The fact that most of the major stock indices are now up year-to-date may reinforce this tendency. Nevertheless, with equity valuations now less attractive and macroeconomic conditions still quite weak, long-term concerns are likely to overshadow the current euphoria and the risk of consolidation is growing. Moreover, the recent strengthening of equity markets should be put into perspective, since it has been limited to the most cyclical sectors, which investors were the first to abandon. The scenario that equity investors have adopted is perhaps already less optimistic than it would appear. We believe the current environment calls for a neutral position.
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“Investment Strategy”sets forth the different asset allocation choices which are implemented in BNP Paribas Asset Management’s portfolios. The investment strategy derives from a running analysis of numerous factors (i.e. the general economic situation, earnings growth rates and financial ratios, assessment of market valuations, technical analysis).