The US stock market continues to rise but we have to ask ourselves "is this justified?" The outlook ...
The US stock market continues to rise but we have to ask ourselves "is this justified?" The outlook for economic growth and corporate earnings is positive enough. US bond valuations look less demanding than they did last summer. Although the stock market has come a long way and inflationary pressures are rising, we believe that prices are reasonably well supported around current levels.
Despite this generally sanguine view, our managed portfolios hold an underweight exposure to US equities. Indeed, over the past three months, we have shifted money out of the US to other areas. This action is vindicated somewhat by the fact that, since the end of September, the S&P 500 has lagged the EAFE index (which incorporates all of the world's major markets outside the US). We expect this new trend to continue.
Like the US, continental Europe faces higher inflation risks than for some time. In both regions, we have seen a sustained period of strong money supply growth and we expect GDP growth on the continent to strengthen in 2000. Countries like Sweden and Denmark are probably most at risk. In the euro-11 countries, money supply growth already exceeds the 'reference rate' set by the European Central Bank. Although 'new economy' stocks in Europe remain attractive on account of excellent levels of reported profits growth, the overall returns we expect to derive from continental Europe over the next six months are small enough to lead us to have an underweight exposure to the region.
The outlook for the UK equity market is more favourable. There are no compelling individual reasons to favour the UK over other regions - simply a combination of factors that reinforce one another. Firstly, GDP growth should continue to rise into 2000. Secondly, we believe that the economy can expand without fueling inflation (money supply growth in the UK has been weak in each of the past three months). One risk is that, by responding to house prices and a tight labour market, the Bank of England could tighten monetary policy to a level inappropriate for the industrial economy. Certainly, sterling appears to be pricing this in.
Our favoured area for investment in Japan, even though the Japanese stock market has advanced significantly already this year. Investors have driven prices up in 1999 because of optimism about corporate restructuring (apparently) underway and because of more accommodating signals from the Bank of Japan. Of course, this could just signify no more than a leap of faith on the part of the investment community but negligible inflationary pressures and improving levels of activity in some sections of the economy suggest that the Nikkei Dow should continue to advance. In our estimation, the index remains significantly undervalued.
Asia poses some interesting questions for 2000. Undeniably a cyclical play on OECD growth, many Asian economies appear to be embarking upon v-shaped recoveries but Asia's stock markets are discounting a pretty positive outlook already. Even the Hang Seng, which has performed far less well than Korea's KOSPI this year is, by our reckoning, as much as 40% overvalued.
We believe that the Japanese and UK equity markets offer the best opportunities and would not be surprised to see Wall Street underperfoming the rest of the world's markets, meanwhile. Growth in Europe should continue to advance but inflationary pressures are mounting in some countries.
Asia may prove to be the 'wild card' in 2000. Should earnings bounce as sharply as some are expecting, then stock prices could move higher again. If earnings don't, however, many markets will look very vulnerable in the wake of gains registered in 1999.
Peter Glynne-Percy is fund manager at INVESCO
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