By GRAHAM FROST 05/02/2010
Further falls in global markets this week leaves many major indices around 9% off their January peaks.
January ended weakly as investors refocused on three issues. Firstly, earlier than anticipated, Chinese tightening caused concern that the major growth engine for the world might be acting too early to prick asset bubbles. Secondly, renewed anxiety about exit strategies occurred as governments around the world began to talk about the need to cut deficits and central banks the need to end quantitative easing. Thirdly, a renewed attack on banks led by the Obama administration in the US, was thought likely to see an international break up of big banks, a restriction on their activities, an increase in capital ratios and ceilings on bonuses. None of these are particularly bad things, but markets worried that they are too early in the recovery process, which remains fragile.
Eurozone
On top of that, there has been a sell -off in Greek bonds due to fiscal imprudence and worries about the solidarity or continued existence of the Eurozone. Investors are concerned the EU will let Greece go forcing it to exit the EU under the ‘no bail out’ philosophy. The cost of that would be huge for Greece, in terms of higher interest they would pay on international debt. The cost may be higher for Europe if this is a Lehman’s moment and it spreads to other fiscally challenged economies like Portugal, Spain, Italy, Ireland, and the UK. We trust that a solution will be found and it will include severe austerity for Greece.
UK
The UK will be forced to have its own austerity program when the next government moves in. We anticipate low growth and low inflation for some time. Interest rates are likely to normalise slowly from thecurrent near zero levels. Over-indebted consumers still need to increase savings and risk assets are likely to remain relatively attractive, despite the economic background, due to the low rates available on cash.
Our view
Overall, we anticipate that global growth in the first half will be supportive of earnings and that the yields on risk assets will remain attractive to investors going forward. However, the issues mentioned may lead to further volatility as markets guess about their impact, but we think modest returns for the year remain the most likely outcome. Stock pickers should have a better year as investors move to quality and mergers and acquisitions pick up.
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