Equity Outlook 2011

be contained. The market is clearly unconvinced that the structural problems are resolved when yields on government debt in the eurozone range from 2.5% in Germany to nearer 12% in Greece. In fact, Irish and Greek 10-year government bond holders have seen their bonds lose about a quarter of their value in 2010, compared to modest positive returns from European equities. Interestingly, we enter 2011 with government debt looking poorer value and arguably riskier than some European equities. For those core European countries where government bonds have escaped the ravages of 2010 one needs a lot of faith in low inflation to accept a 2.5% per annum income from 10-year German government bonds. There are plenty of quality German companies such as Fielmann, the optometrist/spectacles retailer, which yield more and have the potential for dividends to grow over time. Clearly, there are risks to capital by investing in equities but investors can build in a degree of insurance by buying well-managed companies with good business models and strong cash flows. The turmoil in the sovereign debt markets has held back the advance of European equities compared to several other markets in 2010, so from a valuation perspective I believe European equities have the potential to perform surprisingly well in 2011 as this somewhat overlooked market recoups investor interest.

Asian Equities – Michael Kerley, manager of the Henderson Asian Dividend Income Unit Trust: Company profits have risen at a faster pace than share prices so that Asian equity markets look set to end 2010 cheaper in valuation terms than they began the year. Expectations are that Asian companies can grow earnings by a further 15% in 2011, meaning that Asian equities could continue to advance in 2011 without price/earnings multiples even needing to expand. Added to a favourable corporate earnings landscape for the region is a young demographic profile and relatively strong fiscal background, which contrasts markedly with the West. In fact, if there is to be volatility in Asia, the catalyst will likely come from overseas. The monetary expansion in the US is feeding through to commodity prices and asset prices in Asia. There is a danger that inflation gets out of control, requiring a strong reaction by the authorities, although early moves by the Chinese and Indian authorities to tighten monetary policy have been encouraging. Less helpful would be further capital controls to offset liquidity flows. Doubts about the economic strength of the West should also provide further impetus to promote domestic consumption in Asia. Whilst this is already heavily reflected in the fairly full prices of many consumer discretionary stocks, other sectors that are indirectly linked to consumers such as financials still offer attractive combinations of growth and value. Asian financials have largely avoided the fallout from the credit crisis and are able expand in markets that are relatively immature in terms of the penetration of financial products, making this sector one to watch. Overall, I think Asian equities can continue to deliver attractive returns in 2011: the key risk is that Asia grows too quickly, rather than too slowly.

Japan Equity – Michael Wood-Martin, manager of the Henderson Horizon Japanese Equity Fund: Much of the performance of Japanese equities during 2011 will depend on whether the government can convince domestic and overseas investors that an end to two decades of inflation is finally in sight. To do this they will need to ramp up their recent efforts to stimulate growth and press ahead with private asset purchase programmes and efforts to weaken the yen in order to boost exports. Putting in place an inflation target would not hurt either. Should the government be successful, Japanese equities, which are currently valued at levels last seen in the 1990s, would appear to offer considerable upside: corporate Japan has proven to be remarkably resilient and profitability is improving. Past experience tells us that Japan has conspicuously failed to act decisively to arrest its two-decade decline, yet recent events such as the creation of the ‘anti-deflation league’ suggest the tide of popular opinion is turning at last. At a time when the rest of the world is continuing to print money at dizzying rates – having exhausted all other alternatives – Japan may well be the region to watch during 2011.

US Equities – Antony Gifford, manager of the Henderson Horizon American Equity Fund: When it comes to continued economic support, US policymakers have been more accommodative than most. In fact, the Fed has persisted with stimulus measures aimed at fuelling growth long after other countries have been adopting a more hard-line ‘austere’ approach. The signs are now coming through, however, that the economy is beginning to respond. Corporate America has demonstrated a period of very impressive profit growth. The highest quality companies emerged from recession having improved their competitive advantage and increased market share. Investors, however, remain unconvinced, with sentiment weighed down by the stubbornly high unemployment rate and weak housing market. This dichotomy between strong corporate earnings growth and a snail-paced economy is likely to continue in 2011, and we expect to continue to find value in companies where earnings growth and improved fundamentals are not being fully reflected in the stock price. Some of the best investment opportunities to be found within the US equity market will come from those businesses with a greater focus on global markets, particularly Asia and the emerging markets.

Technology – Stuart O’Gorman, co-manager of the Henderson Global Technology Fund: Beyond the obvious new product launches in 2011 such as iPhone 5 an often overlooked dynamic in the demand for technology is the change within emerging markets. Until recently, if emerging market companies were expanding they simply employed large numbers of cheap employees and did not have to worry about productivity, spending comparatively little on technology. Rising wages, however, mean there will be more incentive in 2011 to make the existing workforce more productive leading to an upward trend in technology spending in emerging markets. Wage inflation in these markets also means disposable incomes are rising. Once you have fed, housed and clothed yourself any incremental income is increasingly likely to be spent on consumer discretionary goods, of which technology may be a disproportionate beneficiary. Why? Technology prices, due to innovation, fall every year, and are about to hit a sweet spot in terms of affordability for emerging market consumers. In addition, the relative attraction of technology products is increasing every year – tech prices go down, old economy prices go up. We think this dynamic is true for the developed world – witness the rise in food prices versus the fall in computer prices – but it is turbo charged in emerging markets.

Financials – Emily Adderson, manager of the Henderson Global Financials Fund: 2010 has been a year of challenges for the financial sector in the developed world although their peers in emerging markets saw gains in operational earnings, riding the momentum of good economic fundamentals, combined with a low penetration of financial products and a rising middle class looking for more banking products. 2011 should prove a constructive year for financials in the US and Europe as the uncertainties of 2010 begin to dissipate. We expect to see further improvement in credit quality provided the global economy continues to recover. However, the key driver for higher valuations would be credit growth and the degree of appetite for credit from both households and corporations. Clarification on the regulation of the sector with regards to capital adequacy should also be forthcoming which would improve the outlook for dividends. The first few months of 2011, however, may prove a testing time as sovereign debt fears linger while markets await firm policy action from the European Central Bank to tackle the cascading debt crisis in the region. Financial firms in core European countries with low macroeconomic risk and strong currencies should continue to outperform. In emerging markets, good long-term fundamentals and reasonable valuations make a compelling investment case, but the risk of significant policy action to halt inflationary pressures remains – particularly in China, Brazil and South East Asian countries. In summary, investment decisions in the emerging markets will be based on an understanding of the dynamics of the flow of capital into the region whilst in the developed world the existing discrepancies in valuations within the sector will provide a rich field of opportunities for active investment.