Jul 29 2008
The global stock market rally that began in March has been firmly put into reverse by inflation and the prospect of higher interest rates. This is the view of Tom Elliot of JPMorgan Asset Management. Writing in his Guide to the Markets, Mr Elliot explains that price hikes across Europe, the UK and the USA have all dented investor confidence and have led people to "safe havens". This reversal of fortunes for equities markets is underlined by the fact that the New York Stock Exchange reported interest in short selling to be at an all time high in the last week of June, he states. As many analysts predicted last month, the impact of inflation has not been limited to the western economic powerhouses, with many emerging markets also experiencing price rises, Mr Elliot pointed out.
Looking forward, he suggests that investors might like to opt for government bonds rather than the equity market. He said: "It may well be that in three years'
time, when we are perhaps in a fresh business cycle, we will be able to look back at today's prices and see bargains where currently we see only value traps. But the risk of further stock market falls is too great."
Meanwhile, his colleague David Shairp suggests that economic data indicates a stock market bounce could be due although he warns that "the case is not yet compelling". He predicts that markets will remain "subdued" for the coming months until the trade-off between growth and inflation becomes more manageable and this allows central banks to be more accommodating. One of the factors required for a rally of this nature would be a drop in the price of oil as the current high cost of crude is driving business sentiment down, he states. The second quarter earnings season is still to come and this, combined with headline inflation data, could still "contain unpleasant surprises", Mr Shairp added.
Negative attitudes towards equity markets also dominate the latest Barings Monthly Asset Allocation Views report. According to Percival Stanion, head of asset allocation for the firm, the company is particularly concerned about emerging markets and is reducing the amount of exposure it has in these areas. What exposure the firm does have is concentrated in the "few markets we like", namely - Russia, Brazil, China and the Middle East. Emerging Asia and Singapore are two areas where the firm is less positive, he added.
The reason for this caution is that Asian countries are less likely to have the "harsh experience" of inflation endured by their Latin American counterparts, meaning that there is greater scope for policy mistakes as central banks increase interest rates to help stabilise prices. Investors should be doubly careful as Barings predicts that, despite valuations seemingly offering the potential for profit, earnings expectations in many markets will remain low into 2009.
Looking at alternative investments, Mr Stanion stated that government bonds are attractive in some, but not all areas. He said: "We have identified some value in medium-term government bonds in Europe and the UK, but still believe that US government bonds are unattractive." Long-term Japanese government bonds are also becoming less attractive, Mr Stanion believes.
Threadneedle's chief investment officer, Sarah Arkle, also fears that companies will find their profitability being squeezed. Writing in the Threadneedle Investment Strategy report she warns that rising commodity costs will hit consumer staple companies particularly hard, not least due to the fact that the willingness of consumers to go elsewhere means it is difficult for them to pass on the increased costs. On the other side of the coin, mining firms seem set to continue their good performance due to strong demand from emerging economies and the possibility of merger activity, Ms Arkle states. Investors hoping to profit from any sector should try and identify companies with strong balance sheets and the prospect for good performance, she adds. She does disagree somewhat with the Barings conclusion that equities will remain unattractive for the whole of 2009 stating that current low valuations give "us some confidence for the medium-term".
The Invesco Perpetual Emerging Market Equities report is also largely pessimistic about the outlook for such countries. It points out that central banks in Brazil, Russia, India, Taiwan and South Africa have all increased interest rates, while the fading prospect of a US rebound has "also soured investor sentiment". The MSCI Emerging Markets Latin America index performed badly last month, falling by 7.7 per cent, although year-to-date gains still stand at eight per cent, the report states. While Brazil was the second worst performing country on the index, the it is still reasonable well positioned with "upbeat" economic data underlined by the fact that unemployment fell in May, the company points out.
South Africa is also showing a good level of resilience, largely due to the presence of mining companies in the country which are able to benefit from rising gold and platinum prices, although the nation's current account deficit widened recently.
The firm's Japanese equities report reveals that the country has also been unable to shake off falls in global stock markets and points out that while it is not yet in recession, business sentiment in the nation is at a five year low. The report states: "In recent months, the mood among property developers and financial investors alike has begun to turn sour, with the trend of rising rents and falling vacancy and capitalisation rates going into reverse."
Finally Leigh Harrison, head of UK equities at Threadneadle, warns that the situation could be even worse than has been reported in the newspapers. Pointing to the fact that markets recently saw some "pretty savage moves" as overall prices fell by eight per cent and the struggling housing market, he states that things could yet deteriorate further.
He said: "All through this slowdown the market has been guilty of over optimism. Slowing growth became a soft landing, became a slowdown to negligible growth with risk of recession. Would it be a surprise if we actually had a recession? Or is the surprise how sustained it will be?"
