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5 Key Issues Shaping Current Investment Strategy

5 Key Issues Shaping Current Investment Strategy. Equities: Markets Are Likely To Reward High-Quality Growth Businesses. Across various measures of value, most developed equity markets are hovering around their long-term average levels. What could encourage prices higher?

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5 Key Issues Shaping Current Investment Strategy

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  1. 5 Key Issues Shaping Current Investment Strategy Rathbone Investment Management | July 2014

  2. Equities: Markets Are Likely To Reward High-Quality Growth Businesses Across various measures of value, most developed equity markets are hovering around their long-term average levels. What could encourage prices higher? The transition to rising interest rates is likely to be one of the key events. Companies with little debt should perform best in this environment. Investors are likely to pay a premium for high-quality growth businesses that can make efficient use of existing capital. The gap between the winners and losers has widened. This calls for an active investment approach in order to identify companies with the best prospects. The US offers a wide choice of growth companies. Its economy is benefiting from a broad-based recovery and we believe the US dollar is likely to strengthen against sterling. Continental Europe is our least favoured region owing to the weak outlook for growth. We believe Japan offers selected opportunities. • Figure 1 • The S&P500 Index recorded new highs in the second quarter. But can it continue to climb? • Source: Rathbones, Datastream • Figure 2 • The gap between the winning and losing sectors has widened and we expect this trend to continue. • Source: Rathbones, Datastream Rathbone Investment Management | July 2014

  3. Bonds: Evaporating Liquidity And Tight Spreads May Cause Problems For Investors • Central bank monetary policies are diverging as the pace of growth varies. The US Fed and Bank of England are considering the first rate rises; the European Central Bank and Bank of Japan are heading the other way. • Although the economic outlook has improved in the US and UK, government bond yields have continued to fall. This is unusual. Artificially low prices are probably a side effect of quantitative easing, which has increased demand and reduced liquidity. • We are concerned that bond markets now look over-valued. One of the most extreme examples is in peripheral Europe, where yields have fallen sharply. • There is reduced liquidity in the corporate bond markets, leaving them vulnerable to a sharp and sudden correction. High-yield bonds look particularly expensive. When adjusted for losses and default rates, the additional yield over investment grade offers little compensation. • US Treasury Inflation Protected Securities (TIPS) valuations look attractive, helped by relative weakness in the underlying currency. • Figure 3 • Government bond yields in peripheral European countries have fallen sharply. • Source: Rathbones, Datastream • Figure 4 • High-yield corporate bonds look expensive relative to investment grade credit. • Source: Rathbones, Bloomberg, Itraxx Rathbone Investment Management | July 2014

  4. Disruptive Technologies: The Digital Economy Is Creating Investment Opportunities During our annual investment conference industry experts and specialist fund managers explored how technology is changing how we live and how this might affect investors. The challenge for investors is that technological shifts may not be obvious for many years. The term ‘disruptive technologies’ applies not so much to the initial invention but the point at which it is widely adopted and changes the market. The digital economy is already worth around $2.4 trillion. Yet we are on the verge of massive further changes as we start to realise the potential of the cloud, big data, the internet, robotics, 3D printing, nanotechnology and alternative energy. The labour market is likely to go through profound changes as technology drives down wages and employment levels. The technology revolution is likely to be far reaching and companies in all sectors can benefit from falling costs. Investing in the changes brought about by technology may not be through technology companies. • Figure 5 • Increased mobile phone and internet usage is increasing the potential impact of disruptive technologies. • Source: Oxford Economics, PwC, Emarketer • Figure 6 • Mobile phone penetration is also growing, creating new opportunities for all types of businesses. • Source: Oxford Economics, PwC, Emarketer Rathbone Investment Management | July 2014

  5. Currency Wars: China Is On The Verge Of Devaluing The Renminbi To Support Growth The pace of growth in China has been slowing over the past few years. Recent figures suggest it could be slipping below the official 7.5% target. The Chinese authorities are keen to avoid a further slowdown and it appears increasingly likely that they will devalue their currency, the renminbi. There are concerns that this move could trigger a wave of currency devaluations throughout Asia. In today’s low-growth environment, countries are keen to hold down the value of their currencies, which makes their exports cheaper and supports growth. A wave of currency nationalism could exacerbate existing political tensions in Asia and cause economic instability and uncertainty. There are many positive investment themes for Asia but volatility in the currency markets is likely to spread to other asset classes. Multi-national businesses that are exposed to Asia could find their revenues fluctuate as they translate profits back into their domestic currencies. • Figure 7 • Is a devaluation of the renminbi on the cards? • Source: Rathbones, Datastream • Figure 8 • Can China continue to rely on credit to drive investment and growth? • Source: Rathbones, World Bank Rathbone Investment Management | July 2014

  6. The Curse Of Deflation: Has Economic Stagnation And ECB Inaction Condemned Europe? Most economists agree that the optimal level of inflation is 2% to 3%. Deflation is particularly harmful because it depresses activity by both consumers and businesses. Japan’s experience of a stagnant economy since the early 1990s demonstrates how difficult it can be to break free from a vicious cycle of falling prices. Could the eurozone be heading the same way? Growth is anaemic and inflation is worryingly low. Yet there appears to have been a lack of urgency by the European Central Bank (ECB) to tackle the problems. However, there are also some important differences with Japan. The eurozone is a currency union of 18 member states. Its largest member, Germany, has a vibrant and competitive economy. In addition, there has been some encouraging action from the ECB recently. Despite these differences, growth in the eurozone economy is likely to remain low for some time. • Figure 9 • Inflation has fallen to a worryingly low level in the eurozone. • Source: Rathbones Datastream • Figure 10 • Eurozone growth remains subdued. • Source: Rathbones Datastream Rathbone Investment Management | July 2014

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