LONDON, 1 November 2004 — Assuming that we do not have a repeat of the Florida uncertainties in 2000, the results of the elections in the United States and the market’s response to it will be known in a couple of days!
Even though the US economy had picked up some steam in the third quarter relative to the second, the “new” administration will likely be confronted with an economy that is losing momentum. High oil prices not only act as a tax, they also undermine confidence in what is a uniquely energy-dependent economy. Consumer confidence, never strong thus far in the present cycle, has been weakening in recent months.
On the corporate side however, investment has shown a decent pick-up but is unlikely to accelerate much from here. In this context, one should remember that about half of corporate investment spending is IT-related and the semiconductor cycle looks to have peaked. Meanwhile, US corporations remain reluctant to hire new full-time workers.
In Europe, the picture is somewhat better but chiefly because the cycle is much less advanced. Nevertheless, business indicators, such as the national purchasing manager indices or the German IFO survey, point to some deceleration. Up to now, stronger economies, such as Spain and the United Kingdom, also look as if they are slowing. It is interesting to see that the money markets are now pricing in an end of the trend of rising UK interest rates.
The situation in Asia is more complicated. First, the Chinese economy still seems to be growing very strongly. That raises the possibility of tougher deflationary policies next year and an increased chance of a “hard landing”.
Second, while Japan was unexpectedly weak in the second quarter, it is unclear how far the subsequent weakness is fundamentally economic or whether it has been strongly influenced by natural forces. The Japanese summer was dreadful and has been followed by a series of typhoons and earthquakes.
In a general sense, one cannot but notice the importance of the US market for Asian exporters which would assumingly lead to slower US growth next year. Indeed, a negative factor in the outlook in Asian growth rates.
Asset allocation is currently driven by the forecast of moderate global growth next year based on some moderation in the US growth rate. This implies that corporate earnings next year will likely disappoint the near 11 percent growth projected for the S&P 500. US corporate earnings comparisons with the first half of this year are likely to be particularly challenging.
This would justifiably prompt a 5 percent switch in asset allocation from equities (25 percent to 20 percent) into bonds (40 percent to 45 percent).
On the other hand, the economic outlook is not so bad that a rise in corporate defaults is in prospect for 2005. On this basis, it is worth considering an investment in high-yield corporate bonds.
Although a forecast of further general spread compression is discounted, we still see a better risk-reward trade-off in the high yield bond area than in the general field of common stocks.
On equities, non-cyclical sectors such as health care, consumer goods and utilities are in favor. Elsewhere, retain an overweight position in energy. The Asian markets have also been removed from the recommended list because of the lack of confidence that they will outperform in 2005. On the other hand, the Russian market, although somewhat attractive, is no longer a main feature to include in an investment strategy due to its high-risk nature. Lastly, of the major currencies the Japanese yen looks most promising. The US dollar has declined sharply over the last month. Although it would be hard to forecast further declines from here, it would perhaps be wiser for investors in foreign currencies to pursue a policy of hedging out all forex exposure.
(Habib F. Faris is a vice president at Clariden Bank, London.)
