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Special Report

ESG: The metrics jigsaw

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Foreign issues weigh heavy

Warnings that quarterly earnings could fall short of expectations have certainly dampened the mood among US stock market players. But hopes that the Federal Reserve will cut the price of borrowing soon-er rather than later have buoyed both bonds and equities prices, analysts say.

The lurid details of independent counsel Kenneth Starr's report have fed the tabloids, but financial markets are no longer bothered by the possibility that the re-port might lead to the im-peachment of President Clinton. It's been shrugged off recently," says Alison Cottrell, international economist at Paine-Webber. Opinion polls shows most US citizens oppose impeachment. "If the polls turn then the markets will start to factor it in again."

US government bonds are still supported by the deepening crisis in Russia, which has come hard on the heels of the financial crisis in other em-erging markets. Worries have accelerated the flight to quality among international in-vestors.

"All people care about is quality... it is return of capital rather than return on capital that matters," says Ian Douglas, senior fixed income strategist at Warburg Dillon Read. Demand from invest-ors seeking a safe haven for their money has buoyed bonds in both Germany and the US, he says. This will continue to be the story for US bonds over the coming months, with no let up in the Asian financial maelstrom likely until Japan gets to grips with problems in its financial structure, says Douglas.

Domestically, an organic slowdown in economic activity coupled with net export weakness will push the Federal Reserve into easing rates. Douglas says global econom-ic weakness too is likely to force a Fed easing, and sees a 50 basis point reduction in the Fed funds rate coming shortly.

"Volatility is lapping at their doors, and they can't stand immune to that," he says.

Rob Hayward, economist at Bank of America, also sees the Fed bringing rates down, sometime in the autumn. Fourth quarter GDP is likely to show a moderation in growth rates, but nothing more dramatic, he says, with GDP up two to 2.5%.

As for stocks, the US market is clearly overvalued on a historical measure, says Gabriel Stein of Lombard Street Re-search. But it is still anybody's guess when further correction will happen.

"I've taken my money out of the US stock market al-ready," says Stein. "I don't think it will be where it is in six months' time." The Dow Jones Industrials climbed to 8,024 by mid-September from around 7,500 at the be-ginning of the year, but has fallen steeply from the year's high of 9,337 seen mid-July. An optimistic voice, Goldman Sachs is still forecasting share price rises, with the S&P500 rising to 1,150 in three months' time and to 1,250 in 12 months' time. The index stood at 1,037 in the middle of September.

Douglas also sees more downside for US equities. "The market is concluding that the global economic slowdown will be deeper than thought...by the way it's blown swaps out and corporate paper has been trashed," he says. Many US analysts believe earnings are going to fall short of expectations, leading to an inevitable fall in current overvalued stock prices.

The Asia crisis has had a major impact on US corporate earnings, which some believe was initially underestimated by analysts. Having taken its toll on first and second quarter earnings, for some companies third quarter earnings estimates are also being subjected to downgrades.

The bad news from abroad is not over yet. Warnings about international growth will continue to undermine stocks in the US, says Hayward. "We don't anticipate a major bear market, but there will be no recovery to highs for at least a year," he says.

Stein says the Dow could fall to as low as 6,500. This degree of market slump would normally prove positive for bond prices, but not in view of next year's likely economic environment in the US, Stein says.

He predicts US inflation will pick up over the next year, and the Fed will be seen to be behind it. The market will take the view being that the central bankers should have nipped rising prices in the bud with an earlier rate tightening. Ac-cording to Douglas' more bullish view, the yield on the 30-year Treasury should fall to a low of 4.9%on a three-month horizon. Hayward sees the long bond yield dipping below 5% at the end of the year, then picking up to 5.25% by the end of 1999. Rachel Fixsen"

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