Short term headwinds for Global Equities

Global equity markets could be vulnerable in the short run if oil prices and bond yields keep rising.

Global stock markets have advanced this year on the back of growing optimism about the economic outlook (see Border Newsletter 1/4/06). However, the flip-side of the improving growth outlook is rising bond yields and a re-kindling of the energy bull market, which historically have been headwinds for equities. This year, ten-year bond yields are up more than 50 bps for the G7 countries and are at their highest level in nearly two years, although, encouragingly, inflation expectations remain in check. Meanwhile, crude oil prices are flirting with record highs, in part reflecting investor concerns about U.S.- Iranian tensions and a possible disruption to global oil supplies. Bottom line: While outlook on a 6 to 9 month basis is OK, some near-term turbulence is likely if interest rates and oil prices keep climbing.

If equities wobble, which global markets are at risk in the shakeout?

Several of the world’s best performing markets could be at risk from near term turbulence in global equities.

If rising oil prices and bond yields unsettle equity markets in the short run high-beta stock indexes would be most vulnerable. Mexico, Korea and Brazil have the highest betas to the U.S. and have all soared during the past year. Lower-beta markets such as Japan and India would look to be in better position to withstand any global shakeout, but they too have been major beneficiaries of the favourable global growth and liquidity backdrop, and could take a hit. India looks especially vulnerable given its high valuations and rising inflation. Bottom line: Ultimately global stock prices should be higher by the year end and hence investors may look to augment overall equity market exposure following any near-term weakness.

U.K.: Conflicting Signals

The schizophrenic nature of the U.K. economy means that the Bank of England’s (BoE) deliberations will not be easy.

U.K. unemployment has been rising for nearly a year, climbing close to a three-year high in March. Wage growth (including bonuses), which had been moderating, rose more than expected in February. The baseline view remains that the U.K. economy is entering a renewed mini-upswing within a broad-based cyclical recovery. Most importantly, the budget re-emphasised an expansionary bias with a switch to educational spending from health spending as the driving force. However, the most likely outcome is for the BoE to remain on hold for now. Bottom line: A bias to tighten could eventually emerge on any sign that the labour market is beginning to strengthen.

And finally…………

HAVE A GREAT EASTER HOLIDAY

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.