Funds GreatLink - Great Eastern Life

GREATLINK GLOBAL SUPREME FUND report as at 31 December 2005
is likely to continue increasing against the background of high
corporate profits and the moderate rise in household income,
while structural adjustment pressure, such as the excess debt of
firms, has almost dissipated.
MARKET OUTLOOK
Equity
With robust economies in the U.S. and emerging markets
and sustainable recoveries taking hold in the eurozone and Japan,
the global economy appears poised for higher-than-average growth
despite the drag of high energy prices and rising short-term interest
rates. While energy prices tax growth, their inflationary impact
should continue to be offset by globalization, spare capacity and
rising productivity in many industries, which continues to keep
labor costs and prices for consumer goods in check. With regard
to interest rates, the Federal Reserve is looking to move from an
accommodative policy to a neutral one and not to a policy of tight
money, rate increases by the European Central Bank are expected
to be limited, and the Bank of Japan is under political pressure to
avoid prematurely abandoning its quantitative easing policy. More
importantly, long-term interest rates remain low.
Equity valuations are reasonable, profits are healthy and many
companies, particularly in Europe, are becoming leaner through
restructuring. Corporations have built up cash, and while some of
that is being used to increase dividends and buy-backs, some will
likely be spent on capital investments and employment. Putting idle
cash to work should improve the return on equity for many companies.
In Japan, ongoing structural changes in the economy and
prudent policy measures continue to underpin our belief in a
gradual, sustainable recovery. Equity market valuations continue
to look attractive and earnings fundamentals seem to support
further market upside. We see investment opportunities in industry
consolidation and turnaround situations, beneficiaries of secular
growth trends and rising prices, improved corporate governance
and niche players whose market dominance is well-established.
Fixed income
For the second Fixed Income Viewpoint running, we start our
thoughts with the world energy situation. We make no excuse for
this – in our last Viewpoint we said we did not think oil prices will
be falling back to the $30 per barrel level in the immediate future,
and we continue to hold that view. Indeed, recent events, not least
the interruption to Russia gas supplies to Europe, show quite how
tight the global energy market is, and with OPEC running at close
to capacity, these are structural issues that don’t get resolved in
a year or two. So we believe that high oil prices are, unfortunately,
going to stick around a little longer than expected. We say
“unfortunately”, but for bond markets, the main consequence we
expect is that it should keep a lid on growth running ahead of trend
– which is good news for bond investors as it means that central
banks need not get ahead of the curve in terms of reducing the
monetary accommodation that currently exists in the US, Europe
and even Japan. Interest rates may head higher into 2006, but at a
measured pace. Unless, of course, the impact of higher oil prices
is on increased inflation expectations. That would be bad news for
bond investors in these 3 main regions. However, that is not our
base case expectation. We expect higher rates in the US to start
to bite, with the effect of slowing the housing market and the
consumer by the second half of the year. That should provide the
Federal Reserve Bank sufficient reason to pause around 4.75 to
5%. Bond yields would rise correspondingly, but should be fairly
well-supported by continued pension demand and recycling of
central bank reserves. The curve is as flat as flat can be, with a
slight chance of inversion. If our base case scenario plays out, we
should see the yield curve re-steepening in the second half of 2006.
We are coming close to the end of the US cycle, but are only
beginning to see the start of the cycle in Europe and Japan. The
European Central Bank is expected to bring rates up to about
3%, from the current 2.25%. Again, the rationale is to remove the
accommodative monetary conditions. The front end should continue
to suffer, both against the longer end of Europe, as well as against
the US. Swap spreads should also widen from a combination of
flatter curves, and an expected pick up in volatility as a result of
this shift in monetary policy. In addition, there should be less
swapping activity in the primary issuance market as the flatter
curves provide issuers with less of an incentive to reduce their
borrowing costs to the short end. Inflation bonds should perform
fairly well in line with nominal bonds. There is less expectation of
runaway inflation, now that the central bank is tightening monetary
policy. In addition, oil prices should moderate, although at current
high levels. There is a high chance though that the ECB may find
its work done if the Euro strengthens against the USD.
The UK monetary cycle appears to be the lone one that’s
bucking the general global trend. The problems facing the UK
economy are not minute – deteriorating fiscal situation, a consumer
that’s already heavily in debt, and weak private sector employment
growth. The housing market remains the one pillar of hope for
the UK consumer, and there have been signs of stabilization
recently. Nevertheless, there are strong enough reasons for rates
to be lower than the current levels, not least of all the expected
slowing of inflation rates.
As for the Scandinavian countries, we like Norwegian bonds
as it carries argument for a lot of good news on the economy
fueled by oil prices, and hence rate hikes have been priced into
the yield curve. Inflation has increased slightly, but is still below
the central bank’s target of 2.5%. As is the case for Swedish
inflation, running at less than a percent year-on-year, and more
than a full percent below the central bank’s target. Swedish bonds
should perform in line with European bond markets.
Over in Japan, it’s a case of who has the stronger will – the
Bank of Japan, or the government which points to the last slip
back in the economy being the result of a then premature tightening
of monetary policy. Growth in Japan has been more broad-based,
spreading over to the consumer this year. Capital investment has
been extraordinarily strong in 2005, and is not expected to continue
at its current pace though. From the bond market perspective,
yields are not expected to break out of their current trading
range. Our bias is to be short structurally, however we are mindful
of the huge inflows into the JGB markets from the pools of savings
in Japan. Inflation bonds look attractive.
The mid to long term outlook still remains one of guarded
caution. We have a new man at the helm of the Federal Reserve.
Gearing is still extremely high in the financial markets. Central
banks are walking a tightrope between over-tightening and allowing
the uncertainty over commodities prices to fan inflation
expectations. Hence, bonds still remain a good bet, once the Fed
rate gets closer to 5%.
16 NOTE: This factsheet is compiled by Great Eastern Life. The information presented is for informational use only. The performance of the Fund is not guaranteed and the value may increase or
decrease in accordance with the future experience of the Fund. Past returns are not necessarily a guide to future performance.