Many of the conditions that made 2005 a positive year for investors remain in place. January proved ...
Many of the conditions that made 2005 a positive year for investors remain in place. January proved a rollercoaster month for global equity markets, but market volatility was driven by stock-specific concerns rather than worries about the broader economic outlook.
Economic growth is expected to remain reasonable in 2006, while easing input cost pressures should bring down headline inflation and keep interest rates contained. The Federal Reserve's tightening cycle appears to be nearing its end and the investment outlook will remain favourable provided rates do not exceed 5%.
Earnings in 2005 were boosted by energy and commodities and are now running at historically high levels. As the earnings cycle continues to mature, it is unlikely earnings growth will stay at the kind of levels seen over the past few years, particularly in the US.
Market expectations for earnings growth are largely realistic, with markets now pricing for a slowdown in growth rates. This leaves the MLIM cautiously optimistic about the prospects for global equity markets in 2006.
Earnings growth potential looks strongest in markets with the most scope for robust top-line growth (emerging markets) or for margin enhancement through restructuring (Japan). Investors will be moving away from cyclical stocks and will increasingly favour large cap growth names. Higher quality businesses tend to sustain their returns when profits growth decelerates.
Overall, equities continue to offer good value relative to bonds, which look expensive for their likely return potential.
For US equities, the quarter four earnings season got off to a lacklustre start, with some high-profile disappointments. However, subsequent earnings releases have been more upbeat.
For European equities, valuations are looking stretched with strong performances in 2004 and 2005 closing the valuation gap with US equities. European markets, which are heavily exposed to cyclical stocks, could make slower progress in a rising rate environment. Going forward, opportunities look likely to be stock-specific, rather than market wide, and returns could well be more muted.
However, in an environment where global corporate earnings are running significantly above trend, the UK market has lagged and continues to look good value.
There are signs the housing market is beginning to pick up, while stable interest rates in the UK should ease mortgage repayment woes. This should encourage high street spending, with positive ramifications for UK stocks, in 2006.
January also saw dramatic fluctuations across Japanese markets, following investigation into internet company Livedoor following the position for Asia Pacific equities remains overweight.
Although slower growth from China is forecast in 2006, Chinese consumption should remain healthy, which bodes well for regional demand dynamics.
Global economic growth is expected to remain reasonable in 2006
Emerging markets offer superior earnings growth prospects
UK equities continue to pick up
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