Financial markets are going through one of their periodic bouts of uncertainty. While 1999 was gener...
Financial markets are going through one of their periodic bouts of uncertainty. While 1999 was generally an excellent year, things have been more difficult in 2000, as highlighted by the performance of the Nasdaq, which doubled in value between October 1999 and March 2000 and then fell by around 30%.
There is still plenty of potential good news out there. Inflation is unlikely to race ahead, bond yields have recovered from their lows seen in 1999, cash flow to mutual funds is robust, and the global economy is set to grow this year by around 3.6%. In normal circumstances, this would be a relatively positive backdrop for financial markets.
Once again, the global sell-off was triggered by events in the US, as investors became concerned the Federal Reserve would raise rates more aggressively than envisaged. Similar concerns were seen in the UK, where the Monetary Policy Committee looks likely to raise rates over the summer. Warburgs describe the MPC as "the extremist wing of the sado-monetarist tendency", a view which implies that if there is any doubt about the inflationary outlook, rates will be raised.
Therefore, the time horizon for global interest rates peaking and falling again has been lengthened. With the tightening cycle still firmly in place, investors have expressed their disappointment by taking profits and leaving cash uncommitted on the sidelines. Most markets have tested their 200-day moving average, with the notable exception of Europe ex-UK where the index is comfortably clear of the trend line.
From a longer term perspective, we remain optimistic. The OECD leading indicator chart has now turned down decisively, suggesting some of the steam has been taken out of the world economy. We can expect it to slow towards the end of the year, which will be positive for interest rates and therefore for markets. Bond markets may soon see quite a sharp rally as investors start to anticipate this.
The bond markets are key to the performance of equities. With the exception of Japan, most equity markets look expensive versus their bond equivalent.
A rally in bonds would neutralise this and could trigger the next stage of the long term bull market. If global growth continues to race ahead, then equities will look very vulnerable. In many ways, this is a key moment for the markets, with a possible inflection point near.
We continue to run fairly neutral asset allocation positions. However, we are increasingly interested in recovery from the euro, which would make continental Europe attractive from a UK perspective. The Pacific ex Japan is another favoured area.
With UK equities we continue to emphasise quality growth companies, while we now feel happier holding and indeed increasing exposure to some of the traditional blue chips.
Harry Morgan is head of private clients at Edinburgh Fund Managers
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