Short-term volatility will always feature in equity markets and should be expected. But overall, we believe that equity markets will maintain their positive trend in the months ahead because of the strength of improvement in economic and profits data around the globe. Not only has the US economy reported a better-than-expected improvement in growth (latest data shows third quarter GDP growth revised upwards to 8.2% annualised), but the euro area and Japan are now growing again. In addition, the growth profile is improving: hiring intentions in Europe are rising sharply, Japanese unemployment is falling for the first time in 10 years and US employment – particularly temporary employment – is posting strong gains. With this broader-based activity, investors can have increasing confidence that growth is likely to be self-generating going forward.
The news from many emerging markets is even better. Economies in Asia enjoyed their fastest growth for years last quarter, partly supported by booming growth in China.
Governments are spending more money to stimulate their economies, particularly in the US where government spending increased sharply over the last year. Central banks have cut interest rates to historically low levels in order to encourage growth.
As a result, the world economy as a whole has recently enjoyed its fastest growth rate for several years. More importantly for markets, analysts are raising global profit forecasts for 2003 and 2004. This is partly due to cost cuts made during the downturn, but also indicates that demand is beginning to improve. We expect top-line growth to continue to recover in the first half of 2004. As the current recovery gathers pace it should lead to an upturn in corporate spending, which will further support this positive trend.
There are, of course, some risks to the more bullish economic outlook. Interest rates have begun to rise in some economies and are likely to rise next year in the US. However, even taking this into account, interest rates should remain well below their long-run average. The US consumer has borrowed too much, the $ is weakening (which is making it harder for major exporters in Europe and other economies to be competitive) and the rise in the oil price will also affect economic growth. There are also long-standing structural problems. In the US this is the budget deficit and trade deficit. In Japan, it is the troubled banking system (although here the news is becoming more positive with an improvement in bad loans).
While structural imbalances could ultimately hinder US economic growth, we believe this will not happen until 2005, and they are unlikely to derail equity markets in the months ahead. We believe the economy has built up enough momentum to carry through to the end of 2004.
Turning to the outlook for different markets, we believe those outside the US, such as Europe, Japan and emerging markets, have the most to gain from better global growth. They are more sensitive to improving growth expectations and share prices in these markets offer better value than those in the US. At the stock and sector level, valuations have perhaps run ahead in a few cases, so it is important to be selective. We are focusing on companies which are good or fair value and which are unlikely to disappoint the expectations reflected in their share prices in the months ahead.
We remain cautious on technology stocks. While demand is improving in this sector as companies become more confident about growth and begin to reinvest in their systems, we do not believe the recovery will be strong enough to justify current ratings. Overall we believe that investors are once again losing their sense of perspective in this area – although of course we will continue to monitor the pick-up in demand here.
We are instead backing a recovery in global consumer demand through exposure to luxury goods companies. These companies are not reliant on the domestic economy in Europe, but will benefit from the strong recovery in demand from global – and particularly Asian – consumers.
Mark Pignatelli is head of European equities at Schroders in London

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