According to Pohjola Markets' analysts, the optimistic mood in the global economy early in the year is gone and there is extraordinarily great uncertainty over sustained economic growth. There is a growing risk of a new financial crisis and the greater uncertainty is about to be reflected in both corporate and consumer decisions. The aggressive tightening of fiscal policy would cramp economic growth although fiscal consolidation is indeed a prerequisite for sustained growth in the long term.
The big question in the next few months is how the world economy will grow as the financial system is coughing. In the USA, poor employment figures and the weaker corporate sentiment have increased the risk of a probable recession. In the euro area, business activity is slowing from its high level early in the year but the question mark still is how severe this slowdown will be. Economic development in emerging markets varies strongly but in the main their economies have remained on a vigorous growth path.
A crucial question from the investment strategy perspective is whether euro-area economies can get control of the sovereign debt crisis and at what cost. Our basic scenario still assumes that politicians will find the way of how the euro-area banking system will be rescued, although managing the debt crisis will take many years. The greatest risks and opportunities are associated with solving this problem.
Uncertainties caused by the debt-ridden Southern European economies have considerably affected recent developments in the European banking sector. If European banks had to write down their PIIGS bonds, we estimate that they would need more capital worth 92-185 billion euros. Much of this capital will be needed by the PIIGS nations, and we estimate that this recapitalisation will work through the extended EFSF.
Stock valuations are attractive but before general risk aversion decreases and fears of a recession fade, there will be limited opportunities for a long-term increase in stock prices. Consequently, we will continue our tactical underweight during the second half of the year until there are nascent signs of solving the European sovereign debt crisis.
We expect the ECB to cut its main refinancing rate twice (50 basis points in total) during the next six months. The Riksbank and Norges Bank too are likely to follow suit.
We expect the ECB's expected rate cuts to force the EUR/USD rate down to the level of 1.31 by the end of this year. The CHF bottom and fears of JPY intervention will provide potential for a stronger US dollar in the absence of other safe-haven currencies.
In asset allocation, we will adhere to a tactical underweight position in equities and a neutral position in government bonds. When it comes to fixed-income instruments, we recommend short duration. We will shift to an overweight in Investment Grade corporate bonds and to an underweight in High Yield bonds. Because of the great uncertainty, we will move overweight cash.
Our favourite stocks for the rest of 2011 are as follows: Kemira Oyj, Huhtamäki Corporation, Stora Enso Plc, Fortum Corporation and TeliaSonera. According to our view, stocks that should be avoided include Uponor Corporation, Talentum Oyj, Talvivaara Mining Company Plc and Tieto Corporation.
In corporate bonds, we favour defensive bonds issued by energy companies and technology companies and operators. Our favourite issuers of corporate bonds include Statkraft, Ericsson and Telenor. We recommend avoiding the banking and forest sectors in corporate bonds.
For more information, please contact:
Jarkko Soikkeli, Equity Strategist, tel. +358 (0)10 252 8685
Jukka Ruotinen, Head of Fixed Income and FX Research, tel. +358 (0)10 252 2792