Global markets will peak in 2005 on the back of weaker fundamentals
We believe that equity markets will make further progress in the near term as investors continue to assume risk, encouraged by the oil price easing from record levels and easier monetary policy than originally expected. However, there is a realistic danger that global equity markets will peak in early 2005 as weaker economic and profits data comes through.
As a result, we have cut our 2% overweight position in Japanese equities prompted by a foreseen slowdown in global trade and disappointing recent consumer demand. While we continue to have a positive stance on Japan, we believe the macro-recovery story has eroded in view of the weaker global environment ahead, with falling demand for Japanese exports likely. However, valuations are reasonable and we still expect good profits growth from those companies which are cutting costs and making improvements in efficiency.
Further falls in the dollar are expected to hit Japan more than Europe. We are anxious to maintain an overall overweight in equities for the next month or two, so the proceeds have been split between the UK and Pacific ex-Japan, two areas we believe will outperform if markets are bearish in 2005.
Subsequently, we have increased exposure to the Pacific ex-Japan region, moving from modestly underweight to neutral. The region is now less dependent on external growth and we believe domestic economies should remain fairly resilient in 2005, despite a weaker global backdrop. In addition, China will continue to stimulate activity across the whole region.
We have modestly increased an overweight in UK equities. We expect this defensive market to outperform other equity markets as investors become more risk-averse early next year. In our view, we have reached the end of UK interest rate hikes, while macro data remains fairly upbeat. Combined with valuations that remain reasonable at around 14x earnings and estimated 7% growth in corporate profits in 2004 and 2005, this should create a generally supportive backdrop for UK equities as we head into 2005.
In the US, we remain underweight in US equities. We expect disappointing profits growth in the US in 2005, although a weaker dollar will help. The high oil price will act as a tax on growth and the consumer is unlikely to provide much stimulus. Monetary policy is already too restrictive in our opinion - and we expect rates to peak at the relatively low level of 2.5% early next year.
In Europe ex-UK equities we are moderately overweight. This high-beta market should continue to benefit, as it has done over the last month, from risk appetite among international investors. The economic environment has peaked (retail sales continue to disappoint in the larger economies), but companies in the region are still trading at attractive valuations compared to the US. We remain overweight emerging markets equities, which should continue to benefit from the global equity rally in the near term. Further ahead, a decreasing reliance on exports means that, even with weakening global growth, these economies should sustain relatively strong domestic growth.
Keith Wade, Chief Economist, Schroders Group
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