What’s in store for world markets?
A global bull market in equities started in October of 2002 and still appears to be going strong. Can it last through 2006? There are bulls aplenty who will tell you it can, but it isn’t a given...
A global bull market in equities started in October of 2002 and still appears to be going strong. Can it last through 2006? There are bulls aplenty who will tell you it can, but it isn't a given. The future of the American consumer (one of the world's great economic drivers) is uncertain, energy and other commodity prices are still on the up, inflation and interest rates are rising, and property markets around the world look fragile. Forecasting markets is not easy, but we'd say there's ample room for caution before you dive in to stocks this year. Below, in a round-up of the experts' forecasts, we look at what everyone else thinks about the global markets in 2006.
City analysts are finding the direction of Europe's markets tough to call in 2006. The pessimists point to the fact that the European central bank put up rates to 2.25% in December the first change in more than two years, and one that sparked fears of further rate hikes to come and are concerned about rising taxes in Germany. However, while rising rates are a concern, there is plenty of room for optimism too. The corporate sector is in good shape, with cash flows strong and balance sheets healthy after years of restructuring; markets are still cheap (the average p/e in the German market is still only 14.4 times and French stocks trade on an average of 15 times); and, says The Absolute Return Letter, even if rates are rising, monetary conditions are still much more favourable in Europe than in the US. This means that mergers and acquisitions will almost certainly be a theme in 2006, says fund manager Gartmore. Given that there is "an obvious arbitrage between cheap debt and equity", expect a solid deal flow to support the market and keep a particular eye on the banking sector, which, "given its fragmented nature", is ripe for consolidation.
Many analysts are still tipping eastern European markets for the year ahead, noting that central Europe is attracting $37bn in foreign investment annually (second only to China, and way ahead of India), and suggesting that investors pile into those with the best domestic fundamentals and that are not adversely affected by fluctuations in the price of natural resources. Russia, with its growing middle class, is an obvious candidate to go straight to the front of the queue, but it is no longer particularly cheap, given the perceived level of political risk there. Poland (average p/e 16.7) may be a better bet, says the Halkin Letter. It was something of a laggard in 2005, but is closely linked with Germany, and its media companies have great growth potential. Turkey (p/e 16.5) is another to look at. The economy is growing at 8%, government debt is falling, the country has a young population profile, and foreign banks are waking up to its potential, so the outlook for takeover activity is "bright", says The Zurich Club Communiqu.
The fact that a market is classed as emerging' doesn't have to mean its economies are struggling. And in Latin America, with obvious exceptions such as Venezuela, things look pretty good. Mexico, where the stockmarket trades on an average p/e of 13.4, has already raised the foreign money it needs for 2006 and 2007, and can now borrow almost as cheaply as the US (it pays less than 1% more in the debt markets), while Argentina has just paid off the last of its loans from the IMF, and in Brazil (trading on a cheap looking average p/e of 10.3 times), rapidly declining interest rates are providing an extra source of momentum as is the spending capacity of the growing middle class.
The area will offer much excitement in the future, says Robin Geffen of Neptune Investment Management, but after the strong run its markets had in 2005, this may not be the time to rush in. There could be some "near-term weakness". Neptune will be waiting for this to "buy into selected companies for the long-term".
The United Kingdom
The global economy may look healthy, but the UK's looks "far from enticing", says Greg Bennett, manager of the Neptune UK Equity fund. This year, economic growth is expected to be 2.1%, its lowest for 13 years, thanks to the stagnant housing market, falling consumer confidence and the ongoing dismal performance of the manufacturing sector. Still, most analysts see no reason to write the UK market off completely. Some of the more optimistic, such as brokers the ShareCentre, are forecasting the market to end the year at 6,200 (9% above its current level). Barclays Stockbrokers and HSBC also reckon it'll punch through 6,000, and according to The Sunday Times the consensus forecast is 5,750.
But if this move isn't going to be driven by economic growth, what will push the market forward? Overseas growth, says Gartmore. More than half the combined earnings of the FTSE 100 firms come from overseas, so the index really isn't geared to the UK but to the level of global growth, and barring disaster in the US or China, that looks pretty secure. Merger and acquisition activity is also likely to continue to support stock prices, says Gartmore, and low estimates of economic growth could mean rate cuts in the year ahead, which is good for the British consumer, currently in £1.13trn worth of debt, and hence for the retail sector.
The City appears to expect China to be as much of a story in 2006 as it was in 2005. The country's economy grew faster in 2005 than in either of the two previous years, and growth appears to still be accelerating: despite the prospect of a further upward revaluation of the renminbi and government attempts to rein in state-controlled sectors, such as construction, the private sector is storming ahead. New estimates suggest that the services sector accounts for 40.7% of the total economy, up from a previous estimate of 31.9%, something that in turn suggests economic growth is less unbalanced and more stable than previously thought. Still, while the economy may be on fire, the Chinese stockmarket is a famously bad place to invest. Lack of transparency and shareholder-unfriendly legislation meant that, despite the boom, China's Shanghai and Shenzen fell to seven-year closing lows, down 8% and 12% respectively. So how do you get access to the Chinese market without losing money along the way? The answer, as analysts at Barclays Wealth Management point out, is the same as it has been for some years via mining shares.
The whole world seems to be bullish on Japan. Both major indices, the Topix and Nikkei, are at their highestlevels since 2000, and foreign investors can't get enough of the country, says Christopher Wood of CLSA in Greed & Fear. Foreigners have been net buyers since mid-June, buying 7.3trn worth of Japanese equities. There's one simple reason for this: the Japanese economy is finally recovering, with consumer confidence returning and property prices levelling out. This is "by far the most important development in world capital markets in 2005," and one that "makes the increasingly tedious debate about US interest rate policy, by contrast, look like a sideshow".
The Japanese market does look good, agrees Jonathan Allum of KBC. But after an amazing year, investors should be a bit cautious. The government is beginning to mutter about things like "fiscal retrenchment" and the budget for 2006 predicts government spending will fall 3%. Note too that interest rates will have to rise at some point ("the government's own economic forecasts now show that deflation will be replaced by very modest inflation") and that the market is also not quite as cheap as it was.
The United States of America
The Dow kicks off the year hoping to forget all about 2005, its flattest 12 months since World War II. "The best thing we can say about 2005 is that it's over," says Barron's, but it is hard to think of anything good to say about 2006 either. The Fed finished the year with an inverted yield curve, something that, in the past, has heralded recession. So might there be one this year? Not many think so, but even if there is no actual bust there's lots of potential for slowdown: house prices may well start to stagnate in 2006, say Morgan Stanley, something that could mean a big slowdown in consumer spending (see also cover story on page 20), particularly if new Fed chairman Ben Bernanke keeps hiking rates (the market expects at least one more rise in the base rate). And given that stocks are already expensive in historical terms, on an average p/e of 18.5 times, this could cause havoc in the markets.
Still, there are optimists on the US out there too. If the interest-rate rises come to an end in the first half of 2006 and if this peak in rates is accompanied by "softening oil prices and a firm dollar", then the environment for equities will improve, says Gartmore. Firms will put their capital to work, either through mergers and acquisitions, dividend payouts, buybacks, or increases in corporate spending, all of which are good for share prices.
In 2005, the Indian market, buoyed by fantastic economic growth, beat even the most optimistic of forecasts to rise 40%. This huge leap might mean that some are tempted to take profits in the near term, pushing the market down along the way, says Robin Geffen of Neptune, but that's no bad thing. "In 2006, we will be looking for opportunities to buy cheaply for the long term." Martin Spring, writing in the OnTarget newsletter, also finds the market a bit overheated for his taste at current levels (it currently trades on a p/e of over 17 times, which, given that it still comes with major risks, seems high), but feels if prices fall significantly, "it will then look like a good buy", given the opportunities India has in outsourcing and pharmaceuticals as well as the huge potential of its middle-class consumers.
The wider Asian markets also did well in 2005, but nonetheless lagged behind India and Japan. This, say analysts, has left them looking good for this year. Valuations remain low (average p/es in the region's markets hover between ten and 13 times), yet domestic consumer demand is rising, as is infrastructure spending. And as Martin Spring points out, companies are "stuffed with cash" and profits are on the up, while dividend payouts and transparency are improving. Spring points in particular to Thailand, which suffered in 2005, but which could find its stockmarket rocketing "in anticipation of a deflationary boom"; and to Taiwan (p/e 13.5), which suffered from diplomatic skirmishes with China in 2005, but which has both an undervalued currency and cheap shares to offer. CLSA's Christopher Wood likes the Korean market. Domestic buying has triggered a re-rating, and, "assuming a continuing benign global environment", there's nothing to stop the Kospi going straight to 1,400 (it is currently at 1,334), says Wood in Greed & Fear, something that would put it on a par with the rest of the region in p/e terms.