Outlook 2008: Global Equity Markets

Global equity prices may move higher this year, despite near term risks.

As those who have read BAM’s recent Newsletter will be aware, there are upside as well as downside risks in current markets.

Equities are likely to remain volatile in the near term as growth slows, credit market turmoil persists, and global monetary authorities remain reluctant to provide a more open-ended commitment. However, any equity downside should be cushioned in the coming months by reasonable valuations - both in absolute terms and compared with most other competing assets. As the year progresses, softening economic conditions and easing price pressures should ultimately force significant monetary easing. In turn, improved liquidity conditions will enable market participants to begin looking through near term weakness and start deploying cash sitting on the sidelines.

Bottom line: The bull market in global equities is in a late stage but is not necessarily over. Stock prices could move higher over the balance of this year and outperform both cash and bonds.

Bank freezes rates, but expect to see more soon 

Today’s decision by the Monetary Policy Committee to leave interest rates on hold was purely a matter of timing. With the Committee apparently agreed that a significant monetary loosening is required expect interest rates to fall, perhaps as far as 4% by the middle of next year. 

The Committee’s decision to resist the rising pressure for a second consecutive cut in interest rates may have reflected lingering concerns over the inflation outlook. The recent sharp fall in the exchange rate - and concern that another rate cut might prompt a further drop - may also have played some part, as might the fall in interbank interest rates following recent central bank intervention.

The MPC might also have been concerned that cutting interest rates again so quickly would have be counter productive and smack of panic. However, little can prevent interest rates from falling again soon. Although the conditions in the credit markets appear to be improving, the damage to the economic outlook has already been done. The Bank of England’s recent survey on credit conditions revealed a marked tightening in credit availability to both households and companies. This already appears to be exacerbating the effects of higher interest rates on the housing market. Although the Halifax house price index rebounded by 1.3% in December, this reversed only part of the fall seen over the previous few months. And other housing indicators have remained weak. 

On the inflation front, rising food and energy prices are set to push headline consumer price inflation higher over the first half of the year – possibly close to 3%. But slowing demand in the high street will start to bear down on core inflation and ensure that the headline rate falls back sharply ahead of the MPC’s two-year policy horizon as energy effects fade away. 

Finally, it is unlikely that the fall in the pound (see below) will be sufficient to do the MPC’s job for it. Not only will it do little to ease the downturn in the housing market, but it has been prompted largely by the very expectation that the MPC will respond to the weaker economic outlook by cutting interest rates.  

Bottom line: Interest rates are set to fall significantly from current levels. Rates should fall again in February and may drop to as low as 4% by the middle of 2009.

Technically speaking......Sterling - Stay Bearish

Sterling to under perform both the Dollar and €uro this year.

The pound has been under pressure for several months due to a confluence of too tight monetary policy, weakness in the housing market, softening consumer demand, slowing external demand and easing price pressures.

Recently, there has been a subtle shift in the price action. As can be seen on the chart opposite, this week’s break of the August 2007 low negates the stair-step pattern of higher highs followed by higher lows. Furthermore, several key moving averages have been broken and look set to roll over.

Bottom line: Having fallen through significant technical levels, Sterling may now test critical long term support. Stay tuned.  

And finally...............

An atheist was walking through the woods.
"What majestic trees"!
"What powerful rivers"!
"What beautiful animals"! He said to himself.

As he was walking alongside the river, he heard a rustling in the bushes behind him.

He turned to look. He saw a 7-foot grizzly bear charge towards him.
 
He ran as fast as he could up the path. He looked over his shoulder & saw that the bear was closing in on him.
 
He looked over his shoulder again, & the bear was even closer. He tripped & fell on the ground. He rolled over to pick himself up but saw that the bear was right on top of him, reaching for him with his left paw & raising his right paw to strike him.
 
At that instant the Atheist cried out, "Oh my God!"

 Time Stopped.
 The bear froze.
 The forest was silent.
 
As a bright light shone upon the man, a voice came out of the sky.

"You deny my existence for all these years, teach others I don't exist and even credit creation to cosmic accident. Do you expect me to help you out of this predicament? Am I to count you as a believer"?

The atheist looked directly into the light, "It would be hypocritical of  me to suddenly ask you to treat me as a Christian now, but perhaps you could make the BEAR a Christian"?

"Very Well," said the voice.

The light went out. The sounds of the forest resumed. And the bear dropped his right paw, brought both paws together, bowed his head & spoke:  
 
"Lord bless this food, which I am about to receive from thy bounty through Christ our Lord, Amen”

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