May 2 2007
With UK inflation at a record high, scare stories of interest rates rising a half point, the pound at the $2 mark and fears that the US sub-prime lending debacle could go global, the first quarter of 2007 has been quite eventful.
Despite these fears the Dow Jones closed above 13,000 for the first time in history and UK GDP growth now stands at 2.8 per cent.
Barings Monthly Asset Allocation Views sees Percival Stanion, head of asset allocation, highlight the volatility that stands ahead, especially in the light of the sub prime problems stateside.
He writes: "The past month has seen whipsaw action in the financial markets as the threat of a meltdown in the US mortgage market revived fears of a credit crisis. But the factor most worrying to the market is the lack of clarity over the scale and scope of the problem."
Mr Stanion weighs up both the bearish and bullish arguments - that the US slowdown will have a significant impact on corporate growth and hit export demand or that it is just sector specific and unlikely to spread - and comes out standing between the two stances.
Invesco Perpetual UK Market Update finds that the UK equity market has recovered from a mid-March decline prompted by fears that the US sub-prime falls could spread - but was eventually boosted by merger and acquisition activity.
It states: "Investors' main concern was that the problems in the US sub-prime mortgage market would spread to the rest of the US economy (via sharp falls in house prices) and in turn, the global economy.
"During this time UK banks, such as Barclays and HBOS, were particularly weak due to fears that they could be affected by the problems in the US. However, the UK equity market rallied towards month-end aided by bid activity."
The M&G UK Select Fund - Monthly Fund Review also points to mergers and acquisitions aiding growth in the late part of the first quarter, along with medium-sized firms
"The UK stock market recovered in March following its decline in the previous month amidst a global sell-off. Strong corporate earnings, supported by merger and acquisition activity, provided a positive impetus. Growth was led by medium-sized companies, followed by large companies, while small companies saw more modest returns.
"In sector terms, food producers, autos and industrial transport were the best performers, with leisure goods and pharmaceuticals lagging the market."
Looking at the Gordon Brown's 11th and final Budget, Invesco Perpetual UK Market Update finds that while it "appeared to be hot on substance... the overall impact on the economy was likely to be minimal".
Threadneedle Investment Strategy sees chief investment officer Sarah Arkle admit there is a positive outlook for equities.
"A healthy economic background, which we see continuing in 2008, attractive valuations and ongoing M&A activity all remain supports for equities," she writes.
"We see the market weakness of late February and early March as a normal market correction after a strong rise, rather than reflecting any significant change in the fundamentals. Markets had risen fairly consistently since the last correction in May/June of last year so a setback of this nature should not be a surprise."
Threadneedle has "trimmed" its GDP forecast for the US from 2.5 per cent to 2.2 per cent, while Japan's forecast is upped from 2.2 per cent to 2.5 per cent. China's GDP is expected to hit double figures.
In the UK, Ms Arkle sees interest rates rising to combat inflation - but she warns that the Bank of England may be reticent about hiking rates too high.
"The Bank of England may also tread with extra care as being too gung-ho in increasing interest rates could see sterling spike higher - a move that is unlikely to be sustainable and may make subsequent policy adjustments more difficult," she writes.
SWIP World Market Views Monthly Summary also points to the good position of the equity markets.
It states: "Stock markets have rallied swiftly over the last month and have recovered most of the lost ground. Perhaps this is not so surprising: survey information published just after late February's plunge suggested a strong desire among fund managers to buy stocks. That said, it would be folly to describe equity markets as cheap.
"On the one hand, measures of absolute valuation based on cyclically adjusted trend earnings suggest equities are trading almost one standard deviation above fair value.
"On the other hand, the asset class appears cheap compared to bonds."
The summary continues, reservedly, that combining to the approaches suggests that equities are fair value.
In the Standard Life Investments Global Overview Andrew Milligan, head of global strategy, opts for a defensive asset selection with the background of the US slowdown and concerns in the sub-prime mortgage market.
He writes: There is considerable discussion amongst investors about the outlook for the US economy, and whether any weakness can be offset by strength in other parts of the world. Our view on the US remains more downbeat than the consensus, and we do not believe that all of the bad news is yet priced into financial markets.
"We expect to see renewed weakness in the second quarter, as the housing and manufacturing inventory cycles move down again."
He highlights a major concern to be the US housing market, as the number of new housing starts falling.
The overview also predicts that despite recent volatility in the stock markets the longer-tem outlook for the equities is positive and a healthy corporate sector should extend the current business cycle and bolster key market drivers.
Mr Milligan writes: "While earnings will decelerate into 2007, we still forecast positive growth about five to ten per cent p.a. An interesting development recently has been companies announcing sizeable dividend increases, usually a good medium term signal from management about the sustainability of profits growth. Share prices are being supported through 'de-equitisation', a combination of buybacks, private equity and M&A activity shrinking the number of shares in issue."
He goes on to set out the house view that equity and bond returns are expected to outperform cash over the coming 12 months as inflationary pressures started to rollover.
As the second quarter starts the view across managers can be said to be optimistic but tentative. Problems over the future of US growth still stand as do uncertainties over rising UK interest rates and their effect on the economy - but the mood seems tentatively upbeat with some optimism in equities.
