After April's rocky start, equities spent the bulk of the quarter in recovery mode, although the path to redemption was not always straightforward. For the quarter, the S&P500 was flat, the Nikkei225 slightly negative, while the DAX30 was up almost 5.5%.
Interest rates and energy prices namely oil continued to weigh on investor's minds throughout the quarter as they assessed their likely impact on corporate earnings. While the violent swings in equity markets during April would suggest otherwise, earnings results from both US and European companies were generally favourable with the majority of companies either meeting or exceeding expectations. However, as with most things it was the exceptions that stuck in investor's minds and notable earnings misses such as IBM's shortfall added fuel to the incipient sell off early in the month.
The remainder of April was punctuated by numerous sharp moves in alternating directions as markets weighed positive earnings results against lower guidance for coming quarters and uncertainty over the pace and magnitude of future hikes in official interest rates and energy prices. In the UK, investors were spared some of the ambiguity endured by their US peers after the Bank of England chose to keep official rates steady at 4.75%. US investors had to wait until the end of June to gain further insight into the Fed's mindset with the result being that rates were increased by 0.25% to 3.25% with indications that the Fed would indeed continue its measured' approach to future rate increases; a message that was met with mixed emotions by the wider investment community who had been hoping that the Fed may be nearing the end of their rate hiking cycle.
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With most markets now at new yearly lows, May saw a level of calm return as investors had now had time to digest the likely impact of both corporate and macro-economic events. News was again mixed although events such as the upward revision in US GDP hitting a revised 3.8% after earlier estimates of 3.1% and 3.5% boosted both local equities and the US dollar. Having registered many months of gains against the dollar the euro was now weakening at an increasing rate, a situation that was compounded by France and the Netherlands decision to vote down the proposed EU constitution. While contributing to EU inflation, the euro's weakness provided strong support for European equities through May and June with investors banking on improved corporate prospects as a result of the EU's new found export competitiveness.
The key Asian markets of Hong Kong and Japan were relatively sedate throughout the quarter as China's growth backed off slightly (to 8.9% in Q2 from 9.4% in Q1). This slowed export trade and domestic growth particularly in Japan only partially filled the gap. Japan's latest Tankan survey was remarkably upbeat suggesting that the economy should be stronger in the second half of 2005. However, export growth remains mixed, indicating that Japan will be increasingly reliant on private consumption unless Chinese growth and therefore export demand improves. Hong Kong's prospects have recently improved due to stronger tourism, although with US rates on the rise, local rates are likely to follow suit; a factor which is sure to put pressure on the all important real estate sector.
While providing visions of dj vu from the corresponding period in 2004, the current quarter is differentiated by the fact that it represents the next stage in the Road to Recovery'. While growth was still escalating in Q2 2004, the latest quarter was a period where growth began to ease back to a more sustainable rate and investor expectations had to necessarily adjust. So rather than representing any fundamental failure in investment prospects, the turbulence experienced in equity markets throughout the last three months was simply a reflection of this adjustment process. While currency moves, interest rates and energy prices will continue to exert their influence on markets over the course of 2005, sustained growth in global GDP, some excellent trends in commodity prices and a healthy level of merger and acquisition activity continue to provide a strong case for selective equity investment.
By Bob Michaelson, CIO of SagittSagitta is an independent asset management business to provide wealth management services to high net worth investors and their advisers.
