LONDON (Reuters) - Will the U.S. economy fall into recession and spread its woes elsewhere? Will financial markets dry up in a cash drought brought on by the subprime debacle?
With such Rumsfeldian “known unknowns” as a backdrop, global investors are heading into 2008 with less certainty and less consensus about what to do with their money than has been the case for some half a decade.
Consider the case of Legal & General Investment Management and Morley Fund Management, two large British investors.
L&G is looking to 2008 to produce what it calls “sogflation” — soggy growth with persistent inflation. The result: It expects cash to outperform equities. Accordingly, it is underweight equities and neutral to overweight bonds.
Not far away across central London, meanwhile, Morley is expecting economies to rebound after a recent slowdown and for central banks to contain the credit crisis. The result: It is overweight equities and underweight bonds.
“Although we recognize the risks ... we expect economies to pick up steam from here,” said Morley senior economist John Ip.
Such divergence should not, perhaps, be surprising given the kind of volatile year financial markets have had in 2007. After rising steadily for most of the year, major equity markets began ebbing and flowing sharply in summer.
On a year-to-date basis, for example, MSCI’s main world stock index .MIWD00000PUS was up nearly 13 percent in July, down 1.5 percent in August, up 16.5 percent in November and is heading into the last weeks of 2007 up around 7 percent.
Yields on short-term U.S. government debt, meanwhile, have moved in a more than 2 percentage point range.
Indeed, the best bet for investors might have been volatility itself — the VIX gauge .VIX has gained well over 100 percent this year.
This volatility was triggered by the very things that still hang over investors — credit woes and economic angst. Of the two, the former may offer the biggest challenge because it is truly unknown territory and also feeds directly into the latter.
“The credit crunch is the No. 1 issue,” said Klaus Wiener, chief economist of Italy’s Generali Investments. “Some people say this will be over soon. I think that is not the case.”
It has led Generali to favor bonds over equities for the early part of 2008. “It is not a good time to take risk in the portfolio,” Wiener said, suggesting this could come later.
The big problem with the credit crunch is that it threatens on many fronts — from specific institutions taking huge losses to consumers being hit by higher debt costs to banks failing to find the money for growth.
“We are in a full-blown banking crisis (that) will take quite a while to blow over. We haven’t seen all the contagion effects,” said Fidelity International fund manager Anthony Bolton. “I’m still in the cautious camp.”
It is partly for this reason that the U.S. Federal Reserve, European Central Bank and others took joint steps to ensure a system for lending to banks — moves that were welcomed by investors but where questions remain as to whether it is enough.
At the same time, investors are faced with a slowing U.S. economy and potentially higher inflation risks. Reuters polls show U.S. and European economists reckon there is a 40 percent chance of a U.S. recession. They have also downgraded U.S., UK and euro zone growth prospects twinned with upgrades in inflation.
Investors such as DWS, the German mutual fund specialist, say this risk has not been priced in to assets.
“Fundamentals point to a rough stock market environment,” it said in a 2008 outlook.
As a result, it reckons bonds will do well in 2008 and its equity specialists favor defensive stocks such as drug and telecommunications companies.
None of this is to say that investors are all glum. Many continue to believe that the economy and the credit crunch will shake out, possibly by mid-year.
DWS, for example, is expecting equity price gains of 5-10 percent for 2008 as a whole while others such as giant U.S. investor BlackRock also reckon there may be value in equities.
“Stocks still remain an attractive investment choice,” it said in a 2008 outlook, “although style and sector selections remain critical.”
But the uncertainty facing investors still means a greater divergence of views than since, perhaps, the period after bursting of the Internet bubble.
In Paris, French rivals Credit Agricole Asset Management and AXA Investment Managers have differences similar to London’s L&G and Morley. Credit Agricole is bullish on stocks, expecting the U.S. economy to avoid recession while AXA is negative in the face of too many unknowns.
“We don’t know where the economy is going,” said AXA Senior Strategist Franz Wenzel. “The credit crisis is obviously at the heart of this.”
Additional reporting by Laurence Fletcher in London, Peter Starck in Frankfurt and Blaise Robinson in Paris; editing by Tony Austin