A variety of data suggest that the global economy is tending to strengthen. In the US, the industrial sector has firmed. Even consumer confidence has improved somewhat — helped by a booming housing market and reasonable job growth. US employment statistics show job gains have averaged about 170,000 per month over the last year, and this rate of increase has accelerated slightly over the past 6 months. As a result the US unemployment rate was just 5% this June, compared with 5.6% one year ago.
Although Japanese financial markets have drifted in recent months, we believe that the expansion there remains in place as well. Indeed, the latest Tankan survey shows improved readings, especially from large companies, for business conditions and for employment. Europe has lagged notably in the present global upswing, which is now nearly 4 years old. Nevertheless, surveys now point to an improvement in business sentiment, even in Germany. This year’s decline of the euro has probably boosted margins for European companies. Meanwhile, the likelihood of a change of government in Germany will support expectations for more growth-oriented economic policies over time, even though few expect much improvement in the near-term.
Elsewhere, growth expectations are moderating for countries such as Australia and the UK, where house price inflation seems to have peaked, but developing economies are still growing strongly. China’s growth will be around 10% this year. India and Russia both look set to deliver 7% growth while two largest economies in Latin America — Brazil and Mexico — will report growth rates in the 3-4% range in 2005.
Last month, we suggested that investors seem more prepared to look beyond the present phase of Fed tightening. While this may still be true on the equity side, the recent run of stronger data has shifted expectations in the money markets once again. Futures markets no longer suggest an end to Fed tightening with a move to 3.5% in August but are now predicting 4% rates by the year-end. Despite this, few expect any increase in money rates in either Japan or Euroland over the next 6 months.
Although government bonds have tended to lose ground in the face of rising US rates, they have not fallen much in price. Thus on a global basis, the yield curve is still tending to flatten. Greenspan has already referred to the stickiness of long-term US bond yields as a “conundrum”. Most analysts say this stickiness reflects a global savings surplus — and especially the high savings rates in Asia, but we don’t look for Asian savings habits to change any time soon and therefore expect US long-dated bond yields to stay below 5%.
As far as we can see the US economy is picking up steam rather than slowing. It seems as though the equity markets are coming round to this view as well. Boosted by good news on corporate earnings and an absence of stress in the financial markets, equity markets are developing in a constructive manner. We note also that internal indicators of the market strength — such as the breadth of advancing shares over declining ones — seem to be improving. On this basis we have decided this month to extend our commitment in the equity markets to 35% in out Total Return funds.
While raising the equity weighting to 35% we have cut the position in fund of hedge fund vehicles within alternative investments to 15%. With money rates rising in the US and the outlook for equities improving, these vehicles have lost some of their relative attraction even though they should, over time, continue to outperform cash. Thus alternative investments now represent 20% overall of our Total Return funds as we retain a 5% commitment to real estate. The balance of the allocation is unchanged with bonds at 40% and cash at 5 percent.
While energy remains a core component of our equity portfolios, we no longer predict near-term outperformance and have removed the sector from our favored lists. We suspect that “higher-beta” areas such as emerging markets, IT and biotech will lead further market advances in the near-term. Nevertheless, we continue to advocate a broad spread of equity investments across the main industrial sectors.
(Habib F. Faris is vice president at Clariden Bank, London)
(The information contained herein is for information only and should not be construed as an offer or a solicitation to purchase, subscribe, sell or redeem any investments. While Clariden Bank uses reasonable efforts to obtain information from sources, which it believes to be reliable, Clariden bank makes no representation or warranty as to the accuracy, reliability, or completeness of the information)
