- Even the second liners and the smaller companies, which are particularly sensitive to UK interest rates, are continuing their climb into record breaking ground.
- Hurray for takeovers (that is, if you’re not being taken over). But frankly, it’s not just the corporate activity or the prospect of another private equity deal that’s giving equity markets more ‘welly’. The fact is that the expansion in the global economy is proving to be far more durable than expected.
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For a start, the US economy is surprising by its sturdiness and consensus forecasts are likely to be revised up for GDP growth this year. In the Far East, the emerging giants of Asia, India and China, are overachieving. Growth in these economies is exceeding expectations.
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Japan has lost momentum but is likely to regain it, as its trade is more tied than before to the rest of Asia, which is growing rapidly. Blame the yen’s weakness on the carry trade if you want but the Japanese corporate sector is not complaining. A weak yen enhances its competitive position internationally, and especially throughout the rest of Asia. Finally, there is a firm and improving tone to the trend for economic growth in the UK and the Eurozone.
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The resilience all round underpins the economics driving corporate activity, though it is not the whole story. Comparatively low costs of servicing debt have been important and while the risk to the outlook is higher interest rates, who knows where the threshold lies between a few more ‘bps’ and an implosion of leverage activity generally. The corporate bond markets, which have sensed trouble in the past, appear unfazed. Yield spreads remain historically narrow. There is no hint that the tightening bias in central bank policies is bringing the global economy near to the point of an upset.
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It’s hard not to go with the flow despite the risks, but that’s what investment is all about - taking risks. Our concerns have been twofold. One has been that earnings estimates are being revised downward for 2007. The estimates could just as easily be revised back up later this year, particularly if economic growth remains solid, but then that prospect might not augur well for interest rates. Hence the second concern. Seldom have equity markets been fond of rising interest rates and once interest rates have started to rise, the tendency has been to underestimate how far they rise.
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But one goes with the flow. The comfort factor is the valuation for equity markets. As the chart below shows, the MSCI price index of world equity markets (solid line), which is dominated by the major markets, is nearly back to the peak reached at the turn of the decade but p/e ratios (dotted line) are, on average, no higher than they were four years ago.
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Equity markets have risen more or less in line with earnings over the past four years - something that didn’t happen during the dot com boom. As a result, they are about as attractively valued today as they were in the spring of 2003, when the recovery in global equity markets began.
* The information contained in this report has been taken from public sources and is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. The opinions expressed in this document are not necessarily the views held throughout Brewin Dolphin Securities Ltd. No Director, representative or employee of Brewin Dolphin Securities Ltd. accepts liability for any direct or consequential loss arising from the use of this document or its contents. We or a connected person may have positions in or options on the securities mentioned herein or may buy, sell or offer to make a purchases or sale of such securities from time to time. In addition we reserve the right to act as a principal or as agent with regard to the sale or purchase of any security mentioned in this document. Prices, values or income may fall against the investor’s interests. You should therefore be aware that you may get less back than you invested. Past performance is not necessarily a guide to future performance. If you are in any doubt concerning the suitability of these investments for your portfolio, you should seek the advice of a qualified investment adviser.