BT: Return to stagflation of 1970s unlikely, say Citi analysts (23 Jul 2008)

Return to stagflation of 1970s unlikely, say Citi analysts

Equities' valuations seen as attractive now after H1 fall

By LYNN KAN

FEARS of stagflation - a period of high inflation and slow economic growth - may have been overdone.

Citibank said this yesterday in a report on the investment outlook for the second half of this year.

Equity markets ended the first half on a dismal note as ever-rising oil prices and stagflation fears took centre-stage, said Citi analysts. This year, the MSCI AC World Index was down 12 per cent as at June 27. But the global economy is unlikely to return to the stagflationary environment of the 1970s, Citi analysts believe.

'Slower economic growth is likely to dampen the rapid rise in commodity prices (including oil), which could help ease inflationary pressures over the coming quarters,' the Citi outlook report said.

In fact, because of the substantial decline in equity markets to date this year, Citibank Singapore's head of wealth management Salman Haider said that Citi analysts continue to favour equities over bonds.

'Downside risk is limited and valuations are now attractive,' Mr Haider said in a presentation. He added that emerging markets and European equities were especially attractive.

Inflation should be under control since 'wage inflation has not taken effect fully', said Mr Haider.

However, 'uncertainties over inflation outlook remain considerable', so investors should look to combat inflation by investing in the causes of inflation. These include soft commodities in agriculture as high food prices are unlikely to let up in the short term.

Mr Haider also stressed diversification in commodities by investing in hard commodities. Aluminium and copper prices may prove profitable due to higher labour costs and stronger demand. Gold is also a good inflation hedge, with long term gold prices to double or triple in the 'very long run' and to reach US$950 per ounce in 2009.

With oil prices likely to remain high, Citi's tip is to ride on these prevailing winds in the energy sector. Oil field equipment and services companies should profit from greater exploration activity and investors may benefit as oil majors may pay out higher dividends to shareholders.

To counter 'unforeseen changes in the economic landscape', good defensive sectors in industries with inelastic demand should also be considered, such as technology, oil and gas as well as healthcare as good sectors.

Because strong demand in food and energy from emerging economies have contributed to higher prices for both goods, emerging markets are also good buys. Their growth should remain markedly higher than that of developed economies. Citi's GDP growth forecasts put 2008 growth of emerging markets at over 6 per cent as compared with about one per cent for developed countries.

Mr Haider said that Citi analysts also favour frontier economies in the Middle East and North Africa.

As for emerging markets, oil importers with large current account deficits, such as Jordan and Hungary, 'pose significant risks' while oil exporters in Latin America and Eastern Europe are good buys.

In Asia, investors should look to North Asia rather than South-east Asia despite the former being net importers of oil. 'Implications of rising inflation appear more severe for Asean nations than North Asia because of a higher percentage of household expenditure on food and energy, and they have a higher ratio of exports to GDP so they are more vulnerable to the global economic slow down,' said Mr Haider.

Within Singapore, Citibank overweights the marine and offshore sector in Singapore and certain property developers whose 'valuations are good'. Mr Haider added that some shine has gone out of telcos and real estate investment trusts (Reits).

Turning to address bonds, Mr Haider said that emerging market debt and Asian bond funds may enhance returns as the greenback declines, with the Australian dollar as Citi's favoured currency.
His parting shot to investors is to take a long-term view of investments despite market volatility that may present disappointing earnings: 'It's about seeking a balanced and diversified portfolio and a comfortable risk level. Pockets of opportunity within asset classes may exist for the investor with a holistic view of his or her portfolio.'

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