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Doomsters ousted by soft-landers

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The long-awaited crash in US equities prices has failed to materialise so far, and analysts are now predicting a far gentler scenario – six months of modest growth for the market.
Shares in the US have been surging ahead for years, and many strategists have long predicted the hangover that traditionally follows such a long party. Federal Reserve chairman Alan Greenspan has issued repeated warnings that gains may be unsustainable. But while a series of moderate corrections have dented the value of equities, demand for stocks has always recovered.
The Federal Reserve may move to raise the cost of
borrowing still further in the first few months of the next millennium, but strategists say the Fed’s policy stance will soon be vindicated with economic growth retreating to sustainable levels. And evidence of the central bank’s success in achieving a soft landing will support market sentiment, they say.
Government bond prices are likely to fall as the Fed tightens policy, but prices should rally when the rate hikes slow down, or come to an end.
The euro’s gradual descent to near-parity with the US dollar, while primarily seen as a European issue, could feed through into stronger share prices by keeping inflation muted.
Rupert Della-Porta, investment director for American equities at Hill Samuel Asset Management, says: “We think the environment for investing in US equities will carry on being a good one... and the pace of economic growth will slow down to a more sustainable pace.”
The Fed may have to raise interest rates one more time next year, he says, though he adds that the rise in long bond yields has done a lot of the monetary policy makers’ work for them. Signs of economic slowdown should begin to emerge in the second quarter of the year, and inflation is likely to stay low.
As the US economy decelerates, earnings at US companies should grow at a more moderate pace in the next six months, says Rob Hayward, an economist at the Bank
of America.
But inflation is forming a helpful backdrop for the stockmarket, he says. While market participants have been looking for demand-led inflation, so far, price rises have come from different factors. Any increase in inflation has been attributable to higher energy prices and rises in the cost of tobacco, says Hayward.
However, the US economy could receive a boost from abroad. “We expect a pick up in export growth as the global economy recovers and as the European economy picks up in 2000,” says Hayward.
The euro’s decline against the dollar may have been a worry for the European
Central Bank, but analysts see the European currency recovering to previous levels over the next few months. Hayward says he expects the euro to recoup its losses,
rising to well above US dollar parity, helped by an improvement in European growth. “If (the bounce) were to become more dramatic it may encourage some small-scale switching of portfolios away from the US to Europe,”
he adds.
Although the euro’s slide in dollar terms should in theory be positive for the US equities market, because a strong dollar tends to keep inflation down, in this case it makes
little difference as the dollar is already strong on a trade-weighted basis anyway, says Della-Porta.
He sees the Dow Jones Industrial Average reaching around 11,700 in 12 months’ time – putting on around 5% on the year. This would mean a year of modest growth
compared with the past few years. Just since January 1999, the benchmark has risen by around 20%.
Which industrial sectors will be the outperformers of next year? Hill Samuel favours the technology and telecommunications equipment sectors, and consumer services including media, says Della-Porta.
On the fixed-income side, US bond prices have further to fall, predicts Ian Douglas, senior fixed income strategist at Warburg Dillon Read. “The markets are not priced for the amount of tightening we’re likely to see from the Fed, or the likely pick-up in inflation,” he says.
Concerns about the current account deficit and the tightness of the labour market will spur the US monetary policy setters into further action, he says. Bank Julius Baer analyst Dick Howard sees the Fed hiking rates twice in the next six months, by 25 basis points each time.
The long bond yield will probably climb to at least 6.75% in six months, with short-term interest rates
rising by 50 basis points in
the period, Douglas forecasts. “The only possible
support for the market comes from potential weakness in other parts,” he says. So
if equities do start to
stumble, bonds could see more demand.
In the near-term, Howard sees 20 to 30 basis points upside for 10-year Treasuries. But once signs emerge that the Fed has done its job – when surveys show orders and retail sales weakening, for example – there could be a bond price rally, cutting yields by up to 100 basis points.
However, Hayward sees bond prices rising in the first half of the year, with the
30-year yield coming back down to 6% from around 6.25% now.

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