The economic fundamentals in the different parts of the world hardly show any signs to get very excited about. Europe's economic growth figures are quite meagre, the US economy is expected to slow down and Japan still faces enormous difficulties while economic growth is virtually non-existent.
Our view on 1999 is dominated by several developments. Firstly, the start of EMU and the introduction of the euro could slow the economy down in Europe in the first six months of this year. Businesses as well as consumers have to get familiar with dealing in the new currency and although most systems claim to be 'euro-proof', the proof of the pudding is in the eating. Confidence could fall as a result. An expansionary budget policy is not possible due to high debt ratios in the European countries. The low inflation though makes it possible to cut interest rates, as happened in early December, to create a slightly more expansionary monetary environment. The future external value of the euro does not seem to be jeopardised after the Fed lowered rates twice.
A second important development to consider is the economic development in the different regions that caused major worries in 1998: Russia, Far East and Brazil. Although the im-pact on western economies seems to be limited, we believe that one needs to stay very cautious. The problems have not been solved and additional shocks and spill-over effects could still happen. It is reassuring though that there is a willingness world-wide to work on a constructive solution.
A third very important factor is the role of financial institutions. The banking system in Japan is facing difficult times and the problems will not be solved easily. This year also showed that some western banks have enormous exposures that are much riskier than initially believed. The losses on these positions and the now perceived credit risk, which has led to substantially higher financing costs, could trigger a potential credit crunch. Steeper yield-curves could prevent this, which is in our belief the justification of the latest cuts in Fed rates. Given the expected slowdown of the US economy and the lack of inflationary pressure, there is ample room for the Fed to cut rates further and prevent a credit crunch.
Overall we believe that global economic growth will be limited and in-flation will be subdued. Based on these fundamentals our investment outlook for 1999 can be characterised by a cautious stance towards equities. In the US we foresee pressure on profit margins and lower growth. This is less apparent in Europe and, al-though the actual introduction of the euro could lower business and consumer confidence, we do not expect a substantial change in the economic environment. The risk premium in both regions is rather low and does not offer much profit potential. We think Europe offers relative value and therefore we overweight this region.
The performance of the Japanese stock market is very dependent on the effect of the measures taken. While disappointing thus far, more structural measures are likely. We hold a neutral position in Japan though underweight the Pacific region. The same allocation is used with regards to real estate.
The fixed income markets look in good shape. In a low inflation and moderate growth environment in Europe, the yield curve could move downwards but this move is expected to be limited. The total rate of return will be slightly higher than the current yields. In the US we foresee a greater move though and we overweight this market as a result. We stick to long duration in both regions. The changes of higher rates in Japan outweighs the changes of (even) lower rates. We therefore underweight Japan.
Eduord can Gelderen is manager credit fund at ABP in Heerlen