As the volatility in equity, bond and foreign exchange markets has recently significantly increased, it is necessary to keep in mind some important gauges for a global investment strategy. The outlook for these is as follows:
o GDP growth and inflation: World economic growth, on average for 2000, will be considerably higher than in the previous year and for 2001 see global growth decelerating only moderately. The US economy has been overheating since the second half of 1999 and has so much momentum, that growth will accelerate again this year. However, the restrictive monetary policy and the correction of equity prices from this year’s high, argue for a significant slow-down in the second half. There is some acceleration in core inflation rates.
The economy in Euroland is accelerating, although at a much slower rate than the US. The European economy is not only benefiting from the weakness of the euro, which has improved its international competitiveness, but also from increasing domestic demand. Inflation in Euroland will soon start to recede again and will be benign.
For Japan we are more optimistic than the market consensus regarding this calendar year and next. Growth rates of 1 to 2% seem feasible, given that fiscal support may be forthcoming at any time in the form of further supplementary budgets.
o Monetary policy: Money market rates will continue to rise worldwide
o Asset Allocation: Considering the macro-economic environment, the development of the international bond markets will depend almost entirely on the question of whether the restrictive monetary policy is seen as pre-emptive or as falling behind the curve. Since we expect the former, our outlook for the bond markets is by no means negative. For the coming months we expect yields to move mostly sideways while money market rates will increase further. Accordingly, the yield curves will continue to become flatter. Under this scenario a duration neutral barbell strategy is recommended.
We are less optimistic for the artificially low yields in Japan. Here the slow build-up of a short duration position seems advisable. Considering the currency markets currently, a bottoming out for the euro against the dollar seems to be developing. We expect the euro to at least reach parity against the dollar again in the next 12 months.
The interim rallies on the equity markets after their March/April correction probably do not mark the end, although we still judge the medium-term outlook for equities to be positive. Against this backdrop, the switch into defensive old economy industries is partly tactical in nature (rather than largely strategic), as an outgrowth of the heightened volatility and uncertainty. The scenario for stock markets involves a continuing uptrend for revisions of economic growth and earnings forecasts. We are effectively seeing a return of the traditional economic cycle. The bright side of the dynamic growth is a continued positive earnings forecast.
In response to the good reported earnings for the first quarter in the US and, so far, in Europe, the forecasts continue to be revised upward.
As the high relative valuation of equities compared to bonds has eased little overall, the main pillar of our positive medium-term outlook for the return on shares remains the earnings growth and the implied longer duration of the earnings cycle. Having said this, the average valuations continue to be pulled up by the so called TMT industries and look much better for many other sectors.
Whereas the outperformance of the European markets, since the autumn of 1999, was led by TMT listings, we now see classic themes in the areas of cyclical goods and services and capital goods coming to the fore again as the cycle advances.
For the US, we continue to assume a range trading (for the S&P500 of 1350-1550 points). In Europe, we continue to overweight Germany, France and Italy. In Japan, despite the prolonged sideways consolidation, we like the improved medium- to long-term fundamental outlook. The underlying story remains intact: an economic upswing in the first half of the year, unbroken restructuring of the corporate sector, and resulting growth in earnings.
Bernd Ullrich and Felix Adrian, are in investment research at Commerzbank Asset Management in Frankfurt