By Philip Barleggs, head of asset allocation at Insight Investment Despite interest rate cuts in...
By Philip Barleggs, head of asset allocation at Insight Investment
Despite interest rate cuts in the US and Europe, equity market sentiment remains pessimistic.
Several factors represent significant stumbling blocks, primarily uncertainty over Iraq but now North Korea and the health of the US economy, as well as fears that there could be more terrorist activity to come. In this environment, it is not surprising that government bonds, as the safe haven asset of choice, are likely to remain sought after despite increasingly large budget deficits.
Economic activity remains reasonable in the US but there will continue to be suspicions regarding the reliability and sustainability of earnings growth, particularly if deflationary pressures persist. Many well-known market valuation measures are still high in absolute terms and investors are still wary of an asset class that has fallen for three consecutive years. In relative terms (versus bonds and cash), equity markets offer more attractive value. In the short term though there are sufficient potential negatives to prevent outright optimism for US equities, despite our belief that they will outperform over the course of the year as a whole.
The latest decline in the FTSE 100 has been particularly disappointing given that the news on the economy and corporate profits has been better than that emanating from other western markets and equity market valuations are very attractive in a historical context. Many blue-chip stocks are providing a dividend yield greater than base rates. Company news has generally been in line with expectations; directors' share purchases continue to outweigh sales and there are now more signs of corporate activity. Share buy back activity for a number of large FTSE stocks continues. The recent announcement by the FSA easing requirements on life assurance companies, should reduce selling pressure.
European economic prospects are not significantly positive and will be further undermined as the recent strength of the euro reduces the competitiveness of manufacturing exporters. In addition, the stability and growth pact will force some tightening of fiscal policy when economies appear vulnerable. The ECB is expected to cut rates further but concerns regarding inflation are still prevalent in the minds of the policy makers. Earnings growth is not expected to be spectacular either.
We are exercising caution in respect to the Japanese market and will be monitoring events closely. While September's policy initiatives are a move in the right direction, backsliding on reform remains a real risk. The reform proposals, though beneficial in the long term, will almost certainly do further harm to the economy in the short term and deepen the deflationary pressure. On the other hand, little or no reform action would probably only further draw out the current gloomy situation.
While Asian equity markets have been unable to escape the downdraft from Wall Street, the economic picture in the region is healthy with the World Bank predicting growth will reach 6.1% in 2003, after expanding at a similar rate in 2002. With foreign direct investment accelerating and consumer spending growing, the economic outlook looks encouraging.
Robust reflationary policies worldwide.
UK market is attractively valued.
Growth in Asia remains robust.
Threat if war keeps investors on sidelines.
Concerns about strength of US.
US equity valuations high in absolute terms.
Patience must be a watchword
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