Global equity markets surged during April, with the MSCI World Equity Index gaining 8.9% led by Continental Europe which jumped 15.7% and the UK which rose 10.4%. The US market gained 8.4%. Japan was the only major equity market not to participate in the global rally, down 0.8% in April. Equity markets rallied as the Iraq war ended more quickly than had been expected, oil prices fell, while the US posted better than expected corporate earnings in the first quarter. Bonds continued to rally despite the surge in equities due to weak economic data, and expectations of further rate cuts. The JP Morgan Global Bond Index was up 1.2% in April.
In the run up to the war, we kept an overweight position in equities on expectations of a war relief rally. Since our expectations materialised, with equities outperforming bonds by about 8% in April, we took some profits and trimmed the equity overweight position.
Recent economic data in all regions remains sluggish with a ‘Baghdad bounce’ seen only in a few confidence indicators in the US and UK. Financial markets, however, appear to be willing to overlook the weak data, waiting to see whether the removal of war uncertainty, lower energy prices and improved financial markets will put the struggling global economy on a sustained growth path. In the meantime, we expect the relief rally in equity markets to continue. Further, the six factors we use in evaluating equities versus bonds - valuation, earnings, interest rates, quantitative model, technical and sentiment indicators - continue to favour equities in the US, UK and emerging markets, are neutral for equities on the Continent and negative for Japanese equities. Hence we maintained the equity overweight position, but trimmed the overweight position in Europe and Japan, where currency strengths are a negative for economic and earnings prospects.
We expect long rates to fall in Europe and be range bound in the US, UK and Japan. Hence we remain positioned overweight European bonds; neutral in the US and underweight Japan and the UK. The US bond market has range traded but retained a firm bid despite a sharp increase in issuance and the rise in equities. With the Federal Reserve maintaining an easing basis and economic data remaining mixed, we expect 10 year Treasury yields to remain below 4%. In Europe, the sharp jump in the euro, combined with the likelihood of inflation falling below 2%, should enable the ECB to cut rates in June. Lack of any fundamental reform and deflationary impact of a strong euro should help euro bonds to outperform. Japanese yields fell to a record low of 0.60% in April. While we do not expect a sharp sell off, we believe that there are better opportunities elsewhere, and hence we remain positioned underweight this market.
Among global equity markets, we are positioned overweight the US, Asia (ex Japan) and emerging markets, neutral in the UK and underweight continental Europe, Japan and Australia. On the earnings front, our top down model continues to favour the UK among the developed markets, followed by the US and continental Europe, with Japan ranked at the bottom. We have a big underweight position in Japan as our top down earnings models forecasts earnings to fall by 20%. We increased our underweight position in Europe, as the continued strength of the Euro is a big negative for Europe’s markets relative to the US. No action by the ECB to offset the tightening impact of euro appreciation is another negative.
We increased the US overweight position, as the dollar weakness is a positive for US earnings and exports. Both monetary and fiscal policy are highly reflationary, while our earnings model forecasts healthy earnings growth. We added to emerging markets exposure, as the region as a whole looks promising from an earnings perspective, with the most robust forecast of any of our models. Asia (ex Japan) was moved back to an overweight position from neutral, as there is some evidence that the scope of the SARS problem is better understood, and the problem likely to be contained. The region scores high on our earnings and valuation models.
We continue to have a negative
outlook for the US dollar as the US finds it increasingly difficult to finance the large and growing current account deficit. We maintain an underweight position in the US dollar. We maintain an overweight position in the euro, Swiss franc and neutral in sterling.
John Praveen is managing director, global equities and balanced funds at Credit Suisse Asset Management