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USA: Small caps come through

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A low inflationary 'steady growth' environment is currently sustaining the US equity and bond markets, despite fears in the equity camp of increased volatility in the stock market due to the unpredictability of the Dow Jones.

There is a lot of uncertainty and talk about overpricing and a crash and also a knock on effect from the Far Eastern crisis and Tiger countries, to have a knock on effect on the rest of the world's equity markets," says Joa-chim Nolte, director at Fiduciary Trust in London. While he admits that the worst is behind them, and despite the positive environment, he warns the US stock market should stay on its guard. "We may not be totally out of the woods yet."

Eric Miller, chief investment officer at Donaldson, Lufkin & Jenrette in San Francisco, however, says there is less to worry about for the remainder of this year with a trading range "with a slight upward bias" -the real concern lies in 1998. "I think the major gains have been seen for the year and I think the inhibiting factor towards the end of the year will be some increased concern on how strong earnings will be in 1998," he says.

Accordingly, he expects re-turns at year end finishing at "probably in excess of 20%", an additional 5-6% from the market's current position.

As far as sectors go, small cap stocks remain a strong favour-ite, says Catherine Somhegyi, chief investment officer, eq-uity global investing at Nich-olas Applegate in San Diego, with some of the larger caps offering only "dissappointments" says Somhegyi, "Gil-ette, Coca Cola, McDonalds-some of these companies missed their numbers."

She adds: "The small cap stocks have really lagged since 1994. Growth is very strong there, the companies are do-ing very well but the market hasn't focused on that at all.

"Since June, you've really started to see smaller cap companies do better."

The disinflationary environment means a positive time ahead for the fixed in-come market, says Nolte, with bond yields expected to fall to 6%. The current factors influencing the bond market seem based more on the market's interpretation of events than reality, according to Miller: "The impression of inflation which still looks to be well contained, the perception of how rapid economic growth is, which is likely to remain moderate - probably no violent change in either direction, the continued further drop in the budget deficit and probably a dollar that's going to be a little bit stronger."

He says: "There is a good choice that we could see long bonds ending at about 6.25, but that may not take place until the fourth quarter.""

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