The effects of last summer's oil price rises will make any rally a short-term prospect
President Bush's emphatic election win and the retreating price of oil have set global equity markets up for a traditional year-end rally. Earnings growth may be slowing from unsustainably high levels but is not declining, interest rates expectations are moderating and substantial liquidity is sitting on the sidelines. On balance, therefore, a rally is believed likely. However, longer-term performance may not be as rosy.
The US may have contrasted with the rest of the world by recording stronger Q3 growth than in Q2, but we do not expect this pick up to be sustained. The oil price rise over the summer had a marked impact on real income and wealth. There is still concern that payrolls need to be added to at a faster pace, despite October's bullish numbers, to replace the stimulus provided by last year's tax cuts. Lead indicators also continue to point to a cooling in activity.
Against this background it is difficult not to believe next year will be tougher going, especially in the first half when growth could easily slip below trend. Even so, the US economy is more resilient than many fear, and the extent and duration of the deceleration could be limited and trend growth of around 3%-3.5% may be attainable for next year as a whole. However, there is a greater than usual degree of uncertainty surrounding forecasts given the surge in the oil price and signs that economic activity worldwide is continuing to lose momentum.
This is evident in the UK where a wide range of lead indicators point to softer activity. The housing market and retail sales have clearly slowed in recent months. The consumer has been also joined by the industrial side of the economy for which oil and raw materials are partly to blame.
In the eurozone, similar patterns are emerging. Having grown at 2% rate over the first half, the strong oil price has proven most unhelpful for a sustained rebound in activity. With recovery in domestic demand only just underway and export growth slowing, momentum is already waning as margins are squeezed.
Things are little different in Japan with the economy having been adjusting downward from the unsustainably fast 6% year-on-year growth rate recorded at the end of Q1. Recent data has suggested the growth phase is over.
In the Far East, China continues to dominate proceedings. Trying to divine what is really happening, however, remains an elusive task and the answer is probably somewhere in between headline year-on-year growth continuing to soften but sequential growth beginning to show signs of stabilisation.
While we remain cautiously optimistic that equities will outperform through the year end, we consider this to be a tactical trading call rather than a long-term conviction. We have taken an underweight position in the US believing that, should markets rally, we would expect better returns from higher beta non-US markets. On a longer-term basis, our expectations for US and global growth next year warrant a continuation of a relatively defensive policy.
Andy Brunner, Chief Investment Strategist, Forsyth Partners
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