The April rally in equity markets may not herald the return of a bull market but the recovery is lea...
The April rally in equity markets may not herald the return of a bull market but the recovery is leading asset allocators to favour equities over bonds.
While government bonds have been among the best performers over the past 12 months, many expect prices to lower over the year. Governments and central banks are also likely to be active in pursuing policies aimed at targeting deflation and maintaining liquidity, which is leading some observers to buy into volatility in the equity markets.
Despite mixed economic data flows, stocks should benefit from the macro policies being touted by the major central banks.
Andy Hartwill, global strategist at SG Hambros, says the progress made in the Iraqi war has removed the extra layer of risk perception that clouded investors' outlooks following corporate scandals such as Enron.
'The fact the rally featured cyclical sectors round the globe is a classic response to steeply sloped yield curves in anticipation of growth. It is not the sort of structure expected in a world gripped only by fear. To that extent we believe the rally has further to go, although by no means in a straight line or quickly,' says Hartwill.
Guy Monson, chief investment officer at Sarasin, says for the April rally to continue, more bullish post-war sentiment needs to feed into business and consumer confidence.
Central banks and governments have reacted aggressively, says Monson, citing the Federal Reserve's plans to enact the 'unconventional policies' flagged up by Alan Greenspan at the end of 2002. Monson expects the US to try to flatten the yield curve by capping short- and medium-dated Treasury yields and imposing firm anti-deflationary price targets. While unusual, Monson points to the US government's past capping of longer bond yields at 2.5% between 1942 and 1951 to fund wartime expenditure.
Other measures are starting to be enacted round the globe, he notes. The Swiss central bank is aiming to make its currency more competitive, while its Japanese counterpart is buying bad loans off financial institutions to prop them up and restore confidence. Data remains mixed at best. A better than expected first quarter earnings season in the US has been offset by the continued flow of downbeat economic data.
Tom Elliot, strategist at JP Morgan Fleming, says first quarter data showed a rise in inventories to their highest level since September 2001 and a 0.5% fall in US industrial production in March compared to February.
Monson said: 'Against this backdrop, we certainly see slow growth but not a double-dip that would take us close to a recession. Despite weak data, you need to remember that all key economies will see positive real wage growth this year and that they will benefit too from a fall of up to 30% in oil prices.'
Bonds, like equities, will be volatile in 2003, Hartwill predicts. He says bond prices were driven up by fear, rather than by fundamentals, and this is unwinding as equities rally. Consequently, he expects prices to fall over the coming year and is switching into equities.
Monson also predicts an upturn in government bond yields. Although he does not envisage a mass sell-off of the asset class, he recommends stocks paying a similar dividend to gilts for exposure to potential capital growth.
Equity markets are rallying.
Better than expected Q1 corporate earnings.
Central banks active in trying to boost liquidity.
DB and a lack of alignment
Encouraging better use of tech
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