With global economic growth decelerating in the second quarter and inflation remaining at very low levels, the view on equities is mainly determined by the expected trade-off between slower earnings growth in most parts of the world and improving support from bond yields.

In the first six months of the year the return on equity investments in the US and Europe was again remarkably high. The combination of a further fall in bond yields and a continued rise in corporate earnings (especially in continental Europe) boosted flows into mutual funds in the first quarter. In the second quarter, markets more or less drifted sideways as the Asian crisis intensified. The Asian markets plunged again and other emerging markets suffered from the fall out. Japan continued to be stuck between good value and lack of earnings growth. The implications of Asia for equity markets in the US and Europe were mixed: markets worried about the negative influence on earnings, but were also supported by the lower inflation and interest rates induced by that same crisis.

For the second half of this year, we expect global economic growth to decelerate slightly. The Asian crisis should continue to subdue commodity prices. Wage growth may become a growing concern in the US and the UK (especially in the services sector). However, we think companies mostly have insufficient pricing power to pass on these higher wage costs completely. Therefore, we expect inflation to remain benign, even in the US. After the substantial decline in bond yields year-to-date, we expect yields in Europe and the US to basically remain unchanged in the rest of this year.

European equity markets will probably remain driven by strong liquidity and lack of alternative investment opportunities. After the strong performance year-to-date, markets are overvalued by approximately 10%, but as long as earnings growth remains strong (10+ %) and inflation subdued, it is difficult to detect triggers for a strong correction. In the absence of bad news it is quite possible for markets to remain expensive in a historical context for a prolonged period. With investors repositioning for EMU we expect large caps and southern Europe to continue their outperformance but volatility will re-main high as nervousness about the relatively stretched valuation will emerge from time to time. The valuation of the US market also appears stretched. For this market we are more afraid of disappointing earnings than of rising inflation. In this scenario, the market may lose momentum because of low earnings growth but low interest rates should offer support. Sentiment on emerging markets has obviously been hit again by Asia and Russia. Although valuation levels appear attractive it may take a while for sentiment to recover. It is difficult to forecast how long the crisis in Asia will last but a fast recovery seems unlikely. For Japan the outlook remains uncertain but valuation is supportive. In conclusion, we think the upside for the rest of this year is quite limited. We still favour Europe to the US and Japan (in that order) and prefer Latin America and emerging Europe to Asia.

Frits Moolhuizen is general manager Equities at ING Investment Management in The Hague

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