Too late for China, too early for Asia
Overall, we are optimistic concerning global equity markets even as turmoil in Asia dampens the expectations for global growth and inflation prospects.
Our view of the US equity market is rather constructive. The US economy should produce earnings growth of 7-9% for the S&P500 in 1998 after an approximate 11% gain this year. Productivity growth and stable margins in a solid growth environment will support corporate earnings. We believe interest rates, due to a positive inflation outlook, will continue to decline. Even with a strong IPO calendar, US equities will experience net positive demand. Valuation remains the primary concern.
Attractive valuation as well as high single earnings growth and peaking short rates make the UK equity market attractive. Separately, the new Labour government has indicated interest in joining EMU at the turn of the century. This has resulted in sharp convergence of long rates between the UK and Germany from 150 to 100 basis points. This convergence of rates is expected to continue into 1998, further fueling the equity market.
The economic outlook for continental Europe looks favourable, as an export-driven recovery is well under way. However, valuations are stretched. A key justification for the high valuation levels in these markets has been that the Deutschmark stays weak/weaker, fueling earnings for the heavily export-weighted European market indices. The recent rise in German short rates displays the vulnerability of the markets, the reason for the neutral weighting in Europe. Valuations are expensive and earnings assumptions based upon a weak DM.
Regarding Asia, it is quite clear thatgrowth expectations for 1997 and 1998 are too high. The consensus view is that real gross domestic product growth will fall about 1% in 1997 and between 1% and 5% in 1998, from the former estimated growth rates of 5-8% depending on the country. We think this estimate will prove too optimistic and suggest that growth in 1998 will fall by half; that is between 2% and 4% in real terms. We think portfolio disinvestment is under way, and while this selling may fade by year's end, we see little reason for either growth or momentum investors to return before 1999, or perhaps even 2000.
What about Hong Kong and China? The economies there remain strong and the currency crisis has bypassed China, although the competitive devaluations elsewhere now make Hong Kong look quite expensive. China, the bastion of cheap labour, will face higher costs along the coast but can probably shift production to the centre of the country at still very cheap labour rates. The market has been seen as a safe haven" and is enjoying strong relative earnings versus the region. We think it is too early to invest in South East Asia and too late to add positions in China.
Jon Brorson and Bob LaFleur are with The Northern Trust Company in Chicago"