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Investment
Quarterly - Q4 06:
Fourth quarter 06 market overview |
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| While
global interest rates remain a key consideration for investors,
upbeat corporate earnings and strong economic data have supported
European markets, outweighing the local background of rising
rates, says Alistair Peel |
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Geo-political
events continued to be a feature for financial markets in
the fourth quarter of 2006, with North Korea again among the
headlines. Claims of a nuclear test during October heightened
tensions with the international community. The domestic political
landscape within the US was also a major factor.
The global interest rate environment remained a key consideration
for investors and both the Bank of England and the European
Central Bank increased rates in October and November respectively.
In the US, expectations fluctuated with the prevailing newsflow,
oscillating between hopes for a cut early in 2007, to fears
that the current level of 5.25% may not represent the peak.
Against this background global bond prices were little changed.
UK equities reached their highest levels for five years during
November, with a subdued oil price, strong corporate earnings
and merger and acquisition activity combining to push prices
higher. Despite the continued weakness in the oil price, which
hit its lowest level since late 2005, BP and Royal Dutch Shell
both reported strong earnings, with results from the latter
significantly exceeding market forecasts.
Steelmaker Corus received bids from rival groups CSN and Tata
Steel, with Scottish Power, Laing and Crest Nicholson also
receiving approaches. We currently have a neutral outlook
on UK equities, with valuations generally attractive and earnings
growth positive.
We are more cautious on US equities and expect weakening economic
data to lead to a degree of caution among investors. Third
quarter Gross Domestic Product, at 1.6%, was below forecasts
and there remains some concern about the impact on consumption
from a slowing housing market. However, third quarter earnings
have seen companies exceeding analysts’ expectations
and, again, mergers and acquisitions have helped to support
prices.
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These factors contributed to the Dow Jones Industrial Average
breaking through the 12,000 level for the first time and the
broader S&P 500 index closing above the 1,400 level for
the first time in six years.
Upbeat corporate earnings and strong economic data supported
European markets and outweighed a background of rising interest
rates, with mergers and acquisitions also a positive influence.
Business surveys remained at peak levels, supporting the robust
economic outlook, with third quarter Gross Domestic Product
coming in at 2%, and our full year expectations remain at
2.5%. Inflation fell below target, helped by weakening energy
costs, but is expected to pick up again; with the economy
remaining firm, interest rates are likely to move higher.
Japanese equity markets traded at around the same levels at
which they had started the year, with investor focus largely
on the global and domestic economies. The prospect of a controlled
slowdown in the key US economy helped to support sentiment,
but concerns remained about the sustainability of the Japanese
economy. The economy grew at an annualised rate of 2% in the
third quarter, more than double expectations, but softening
data has since raised fears that the fourth could see a sharp
slowdown.
Emerging Markets enjoyed a generally upbeat trend, with many
achieving record highs. The lower oil price and the potential
for a ‘soft landing’ for the US economy bolstered
sentiment and saw markets in Mumbai and Indonesia hitting
the highest levels in their history.
Momentum in the Chinese economy was maintained, with bank
reserve requirements increased in an attempt to slow the rapid
pace of lending.
We continue to prefer equities to bonds in the current environment,
with Asia ex-Japan and Global Emerging Markets our favoured
regions, reinforcing the need for a global investment perspective.
We expect strong economic and earnings growth in these areas
and high investment liquidity should also continue to lead
these markets higher. The potential returns and additional
diversification provided by hedge funds, property and private
equity make these asset classes important elements in portfolio
construction.
In considering a well diversified investment strategy, funds
free of benchmark constraints provide an additional avenue
for enhanced returns, with funds concentrating on Absolute
Returns providing useful downside protection while still offering
potential returns in excess of cash deposits.
Alistair Peel is director, charity services at
HSBC Investments
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