The most important question for global asset allocation in the coming months is timing and the exten...
The most important question for global asset allocation in the coming months is timing and the extent of a US consumer slowdown.
Investors are now playing a waiting game, cautiously eyeing the steady trickle of economic data from the US. Until the Federal Reserve has made it unambiguously clear the next move in interest rates is down, markets will most likely remain hamstrung by uncertainty.
The effect of this is cash levels are building up - by some estimates they are now at record levels among institutional investors.
When investors are certain there will be a soft landing, equities may be in a position to make some headway. If investors assume the US economy is slowing down rather than going into reverse, then any future setbacks may present good buying opportunities, especially as valuations remain unstretched.
However, asset allocations should not only focus on the US but also on other markets, which have been showing signs of significant recovery.
Although US equities make up about 50% of the FTSE World's market cap, they are only showing cautious progress.
For investors willing to stray from the confines of their benchmark, there remain some interesting areas to investigate.
One area to overweight is Japan. In Japan, the first quarter earnings season (for the period April-June 2006) has helped the equity market. Most companies have now reported and the numbers have been ahead of expectations for both exporters and domestically focused companies alike. Sales have risen by nearly 11% year-on-year and operating profits by nearly 19%, according to one investment bank. These are impressive figures and, on this evidence, earnings are already on track to beat forecasts for the rest of the year. Strong earnings growth should see equities outperform.
Though sentiment in the Japanese market has been weak since the rally of the latter part of 2005, it has now improved. The Topix index has recovered about half the ground it lost from the peak it reached in April. The rally last year was driven by geared foreign investors, who suffered in the subsequent shake-out. But as investors have now taken the pain, there is a better basis for a more sustained recovery in the market.
The fundamentals in other regions remain firm as well. In Russia, public finances are solid, given its huge currency reserves and budget surplus. Valuations there are also at reasonable levels after the recent correction. Growth elsewhere in Eastern Europe continues to be strong too.
In China, the economy remains hot, to the extent that the government is increasing its efforts to cool off an overheating economy by tightening bank reserve ratios. The central bank has raised interest rates for a second time in four months.
Although there are plenty of growth opportunities in other emerging markets, investors are waiting to see what happens in the US.
There are imbalances that have to be unwound. US consumers need to start saving again and stop relying on equity in their houses to fund their lifestyles, but ideally not so quickly that they derail global growth. The autumn could prove to be a tricky few months - getting your asset allocation right could prove vital. key points
Investors cautious about the US
Japan has been performing well
Russia economy is looking good
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