Despite economic activity slowing for three major global contributors (China, Japan and the US), we expect economic growth to exceed trend for the remainder of this year and into 2005. SSgA economists expect US growth of 4 per cent for both Q3 and Q4 and 3.5 per cent for 2005. As a result, monetary policy will continue to tighten, requiring greater conviction for the seemingly no-lose carry trade.
Oil at $50 a barrel has most investors worried about the corresponding negative consequences for equities. However, we differ from the market. After analysing data globally, we conclude that current oil prices cannot be maintained for an extended period and eventually we expect supply/demand dynamics to dictate and hence force down prices.
Politics, oil and instability in Iraq continue to dampen enthusiasm for US equities. Tighter monetary conditions have resulted in lower bond yields while equity investors fret over the potential of higher interest rates due to tighter monetary conditions. Certainly, the US capital markets are marching to a drum few, if any, have ever heard. That being said, defying the natural laws of the capital markets cannot continue indefinitely.
Valuations are trading at 15.7x forward 12-month forecasted earnings, which given the current 10-year Treasury yield, would suggest that investors should choose stocks over bonds. Our research suggests that the appropriate multiple for the markets should be closer to 17x forward earnings, given our expectations that 10-year Treasury yields should end 2005 near the 5.5 per cent level.
Concerns regarding economic sustainability dominate investors’ psyche and, as a result, bonds remain the flavour of the day. However, in light of our expectations of slightly above-trend growth for 2005, we continue to favour stocks over bonds over the next 12 months.
Stephen Burke, senior global strategist, State Street Global Advisors
|
|
North America: US growth to exceed expectation
October 2004
Like a phoenix rising from the ashes, the global bond trade has once again revived despite the best efforts of the major central banks. Bond yields have fallen throughout the developed markets as the ‘carry trade’ (borrow short, buy long) has been resurrected as one of the few sure bets in the global capital markets – aside going long oil, of course. Forgive the cynicism, but a 4 per cent 10-year US Treasury yield while the Federal Reserve is in tightening mode leaves us a bit queasy. Strained global economic activity is providing credence to the carry trade, contrary to conventional wisdom that rising central bank rates should foretell rising government bond yields. Related articles: |
E-mail Updates
|
