For fund managers, the high level of the western equity markets has been a concern for most of 1997, and in the case of Wall Street for longer still. The fundamentals, however, have remained stubbornly benign, frustrating the bearish inclination of institutional investors.
Until there is an actual reversal in the fortunes of the global economy, markets will continue to thwart the natural nervousness of fund managers. Even Alan Greenspan's recent cautionary words on the US stock market will count for little if the Fed leaves monetary policy unaltered. Previous comments from Greenspan on uncertain longevity" and "irrational exuberance", have caused only temporary blips in markets, precisely because they were not followed by significant policy shifts. The Bundesbank obviously believe that actions speak louder than words!
The absence of any visible inflationary pressures has allowed interest rates globally to remain low for a historically long period, even as economic activity has begun to revive in the West. The persistent economic malaise in Japan has exagerrated this trend, leading to an excess of liquidity that continues to find its way into financial assets.
Bond markets' strength worldwide does not suggest that equity markets have been following a path of self-delusion in recent months. In 1987, by contrast, bonds yields rose sharply in the months ahead of the crash.
Despite the excellent performance of the British, European and American equity markets we see little reason to lose faith in these markets while the fundamental background remains positive.
The outlook for Asia, however, will remain uninspiring until there is a significant improvement in the management of these economies. Cash yields will continue to become more competitive against bonds as the global economy accelerates into 1998 keeping us underweight in bonds against cash. Equities remain the asset class of choice, albeit with more modest expectations for returns than achieved over the last few years and with higher short-term risk.
November will prove to be a crucial months as the world waits to see if Alan Greenspan follows his rhetoric with policy action. If not, expect the bull market to return.
Andrew Parry is director of equities at Julius Baer Investments"