Jun 26 2006
From Japan and the US to Brazil and India, global financial markets suffered in May on the back of rising US inflation and concerns over interest rate growth in the world's largest economy.
Amongst the major equity markets, Japan's Topix performed the worst, with Invesco Perpetual [Report] citing local companies' sensitivity to the outlook for export demand.
The same factors applied to Europe, whose market was the second worst performer despite improvements in the eurozone economy and gains in the manufacturing industry. Analysts [Report] (Schroders) point to the biotechnology as one of the few sectors that posted positive gains in May, mainly on the back of Elan Corporation, the Irish drug firm that is expected to gain US and EU regulatory approval this summer for a multiple-sclerosis drug. Conversely, industrial, aerospace and technology were the weakest sectors, with falls of up to ten per cent.
Meanwhile, the UK’s FTSE All Share also suffered, falling 5.1 per cent – slightly less than its main counterparts in Japan (8.0 per cent) and Europe (5.8 per cent). The UK equity market was driven down by concerns that record oil and metal prices could fuel global inflation and consequently trigger global interest rate hikes. The Bank of England predicted inflation to rise above its two per cent target in the coming few months, further fuelling the market downturn. The Aerospace & Defence sector was particularly hit, with engineering company Rolls Royce leading the decline.
In the US, markets suffered from the same concerns over interest rate growth, as well as a rise in crude oil prices which dampened investor appetite. Expectations of interest rate growth were sparked by economic news that indicated sustained short-term economic growth, which could further fuel inflationary pressures and subsequently interest rates. However, evidence of a drop in consumer confidence suggested spending and economic growth may decline in the next few months.
The emerging markets were especially rattled, with Brazil and India leading the declines. Both markets suffered from drops amongst key players in the metals and mining sectors, as well as concerns that the rapid economic growth in the respective countries may be easing – fears fuelled by concerns over global interest rates, which affected emerging markets across the globe.
South America's freefall was exemplified by MSCI Emerging Markets Free Latin America (US$) index, which suffered its biggest monthly fall since the 9/11 terrorist attacks in 2001. Investors were driven to selling local stocks by the prospect of higher US interest rates and sliding commodity prices.
Similarly, in Mexico stocks fell in May despite upbeat prospects for the local economy, but Chile was the region's top performer – the Chilean Stock Market Select index suffered a minor loss – as its economy continues to benefit from record prices for copper, its main export earner.
OUTLOOK
Despite May's meltdown, long-term prospects for emerging markets in general remain healthy [Report] (AXA Framlington) as domestic demand strengthens and growth becomes less dependent on exports. However, the short-term situation remains volatile while higher interest rates in the US and Europe blight the attractiveness of emerging markets.
Furthermore, analysts [Report] (AXA Framlington) anticipate two or three further interest rate hikes in the US but by the end of 2006, with slowing economic growth and inflation under control, rates should stabilise. With economic growth likely to slow, the performance of growth stocks should improve in the US.
Within Europe, some analysts [Report] (AXA Framlington) favour peripheral markets such as Scandinavia and Ireland over more established ones. However, others [Report] (JP Morgan) believe European companies are set to deliver strong earnings growth, while healthy M&A activity should keep the market afloat. Yet concerns remain that the European Central Bank will raise eurozone interest rates too soon.
JP Morgan [Report] also expects a continuing flurry of M&A activity in the UK which should boost the domestic stock market. However, it expects only a steady return for the UK equity market, with concerns over consumer spending, threatened by high levels of personal debt and higher utility bills, dampening optimism elsewhere.
In Asia, Japan should be buoyed by growing domestic demand for goods and services to accompany strength in its export market, but JP Morgan [Report] particularly favours China, Taiwan, Indonesia and Korea. However, it remains cautious about the short-term prospects of emerging markets, with US interest rates concerns cited once again, as well as evidence that investors may be curbing their appetite for risk.
So overall the longer term prospects of global markets appear healthy, but investors should be prepared for further volatility in the short term.
