At the start of 2011, economists were forecasting global growth of more than 4 per cent, and therefore a favourable backdrop for equities.
UK government bonds were yielding 3.5 per cent and looked expensive, with most forecasters expecting interest rates to rise at some point in the year. Further problems in the Eurozone were foreseen by many, but few predicted the civil unrest experienced in the Middle East and north Africa. This highlights the dangers of expecting forecasts to prove to be correct.
This might seem an unusual way to start examining what could happen in the remainder of the year, but I plan to have a go nonetheless.
Although the biggest economic surprise would be if forecasts turned out to be correct, there is a value in seeing where forecasts exceed or miss expectations. In particular, changes in economic forecasts normally lead to changes in forecasts for corporate earnings. Investors generally base their investment decisions on the future cash returns likely to be generated by their investments, normally discounting these back to the present day to see whether an investment looks like good value. As earnings forecasts change, so do the potential discounted cashflows and the merits of the investment.
The biggest changes to growth forecasts since the start of the year are: a general downgrade to US economic prospects; a belief that the earthquake and subsequent tsunami in Japan would cause it to slide back into recession; and a belief that growth in Germany and Brazil would turn out slightly better than expected in 2011. The net impact of these changes is that economists now expect global growth to be 3 per cent to 4 per cent rather than "over" 4 per cent. Consequently, we can expect a slight lowering of earnings forecasts, although they should still show good growth over the year.
Equities have performed less well than might have been expected at the start of the year, with the UK equity market losing value in capital terms but producing a marginally positive total return once one includes income. Bonds have performed better, helped by the weaker outlook, and so now yield only 3.2 per cent.
Hence, although the outlook is less rosy than it was at the start of the year, we still expect reasonable growth going forwards. Our view remains that government bonds, yielding only 3.2 per cent at a time when inflation remains well above this level, look unattractive on anything other than a very pessimistic economic scenario. UK equities offer the same yield (3.1 per cent historically) and are likely to produce good dividend growth over the next couple of years, so look good value compared with bonds. Overseas equities have produced slightly lower returns for sterling investors.
In addition, charities can invest in common investment funds invested in commercial property and yielding roughly 7 per cent, which looks very attractive against bonds or cash.
We continue to think that charities should bias their investments to real assets, such as equities and properties, as they remain good value, offering attractive yields and a rising income.
John Hildebrand is an investment manager at Rensburg Sheppards