In the short term major Western markets are set to continue to move sideways as investors try to sec...
In the short term major Western markets are set to continue to move sideways as investors try to second-guess the intentions of the monetary policy makers. That said, it is not inconceivable that equity markets can do well against a backdrop of rising interest rates.
Fundamentally the trend of core inflation remains stable to downward and strong economic growth will help generate healthy increases in profits. The disinflationary and intensely competitive pressures which prevail globally will sustain the corporate activity and industrial consolidation that has been underway for some time.
In other words, the US market's sluggish start to the year should not disguise the fact that, with expectations for corporate earnings being revised upwards, the underlying health of the North American economy is strong. For the moment expect equities to stabilise, although any major bouts of weakness should be snapped up as a useful buying opportunity.
The UK's monetary custodians are also well versed in the harsh lessons of successive booms and busts. It is now more than possible that better than expected high street sales in December and burgeoning external demand could prompt a base rate in excess of 6.5% by mid-year.
The Monetary Policy Committee's concern is understandable as successive rate hikes have brought no evidence of a slackening in the economy. Indeed, wage growth is exceeding inflation by about 3% so productivity growth will be crucial. We nevertheless believe that cost savings from rapid growth in business-to-business use of the internet will keep inflation in check despite the growth in capacity.
While we expect the broader UK market to trade within a range for the time being, technology stocks are geared up to push even higher as little of the previous quarter's momentum has been lost. Going forward, stock selection will be key and investors will have to look towards the smaller cap sectors as the FTSE 100 continues to struggle. Followers of blue chips may only find solace from interest rate sensitive financials which, as they enter their reporting season, stand to benefit from rising bond yields.
Eurozone interest rates are historically low, so any increase could be viewed merely as a sanguine response to strong economic growth rather than an attempt by the European Central Bank (ECB) to arrest the euro's slide. However, if the currency dips further, the ECB may feel constrained to manage sentiment by pushing up rates more strongly.
This could undermine any rebound in cyclicals and further concentrate the already narrow market leadership of the 'new economy' sectors. That said, restructuring and merger and acquisition activity will remain positive themes for European markets. This is especially the case in Germany where the proposed elimination of capital gains tax on share holdings of companies should accelerate industrial consolidation.
At the other extreme of the economic cycle, Japan is continuing to emerge from its doldrums. Support for the equity market is improving thanks to the restructuring of the corporate sector and the expected recovery in corporate profits. On a 12-month view, earnings are expected to double, and this will be critical in helping the market build on last year's gains.
Although the consumer is likely to remain weak for a while, substantial inflows of foreign investment are also likely to be treated as welcome news for the equity market. The Japanese resurgence should inject further vigour into the Asian economies, where regional equity markets look moderately priced in relation to expected earnings growth. We now feel there is a case for cautiously overweighting the region.
Logie Cassells is fund manager at Capel Cure Sharp
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