The year 2000 ended up being
the worst year for equity markets since 1990 when
the Gulf Crisis took its toll on equity markets.
Unlike that single event that put markets in a
downward spiral, 2000 was more of a steady decline.
The United States was in the middle of the storm,
sparked initially by concerns relating to economic
imbalances and more recently by the deteriorating
outlook for corporate profits and the overvaluation
in "new economy" shares.
It is often said that when the United
States sneezes, the rest of the world
catches a cold. The strong US economy has proved
to be a double edged sword for the rest of the
world in that it has ensured a ready market
for the world's exports while on the other hand
it has created headaches for the likes of the
European Central Bank, because the longer the
boom in the US continued, the more global investors
wanted to invest there rather than in their
own economies or in the other economies. Money
poured into America and the dollar soared. This
resulted in other parts of the world being starved
of much-needed inward investment. The strong
dollar resulted in Europe experiencing problems
with rising import prices. This in turn put
further upward pressure on interest rates. A
weaker US economy may result in a drop in imports
from the rest of the world, but on the other
hand it means that places like Europe will enjoy
greater investment inflows and a lower level
of inflation and interest rates. One house view
is that the US equity market is unlikely to
impress for some time to come - firstly because
valuations in certain sectors are still fairly
high. Secondly surplus capacity as a result
of the investment boom of recent years is likely
to keep a lid on corporate profits. Finally,
with the current account being rather large,
the level of US economic growth must remain
below that of its trading partners.
The US Federal Reserve cut interest rates by
one percentage point in January to bring interest
rates down to 5,5%. Many investors believe that
further interest rate cuts will be required
in the near future in order to sustain economic
growth in the light of the weakening manufacturing
sector and disappointing retail sales. Another
source stated that corporate profits continued
to grow during the second half of 2000 - but
not as fast as previously expected by analysts.
There is always a lag between interest rate
cuts and its impact on the economy. The US stock
market is likely to remain uncertain until the
outlook for the economy and companies' profits
have become clearer. Another house view believes
that the American economy will have a soft landing,
primarily due to the fact that the Federal Reserve
started cutting interest rates quickly and that
they are likely to continue to do so in the
short term. The unit cost of labour is falling,
which is a sign of efficiency and there appear
to be no inherent structural problems. Potential
tax rate cuts are likely to spur on consumer
confidence together with the potential increase
in government spending.
There appears to be consensus regarding the
outlook for Europe.
Stock market volatility has persisted in Europe
- TMT stocks have been affected by swings in
sentiment and earnings results and forecasts
in the US have influenced investors and their
confidence levels significantly. Although the
short-term outlook for Europe remains uncertain,
over the medium term the outlook is more positive
for European equities. Merger and acquisition
activity is expected to remain brisk and the
economic background in Europe remains more favourable
than in the US - this is despite the indications
that Europe's expansion may have peaked. The
recent strength shown by the Euro may reduce
the competitiveness of the export sector, but
lower oil prices should prove positive for both
growth and inflation. Another school of thought
is that with the Euro finally stabilising after
months of poor performance, European equities
should perform well.
Fidelity's view on the United
Kingdom is as follows - "UK equities
have not escaped the unsettled conditions seen
elsewhere. The UK market is likely to continue
to be influenced by events in the US, particularly
by investor sentiment towards technology and
technology related stocks. Interest rates in
the UK have been kept on hold for almost a year,
but rate cuts in the US and signs of a slowdown
at home have led to widespread expectations
that the Bank of England will reduce base rates
in the near future. Inflation remains below
the central bank's target. A cut in rates would
most likely be positive for the stock market
and corporate bonds. We believe that the outlook
for smaller and medium - sized companies remains
attractive and the overall environment for stock-picking
has improved."
In Asia stock markets
are prone to sharp swings - political instability
in some countries also has a dampening affect
on investor sentiment. The economies of South
East Asia are still expanding - private consumption
is taking over from export growth as the key
driver of economic expansion. Some are of the
opinion that Asian companies appear to be attractively
valued overall - there is a need, however, for
business to issue new equity to strengthen their
finances.
Investor sentiment in Japan
is fragile and is likely to remain so in the
short term. In the long term, sustainable economic
growth depends on the recovery of consumer confidence
and on continued corporate restructuring to
make companies more efficient and profitable.
One school of thought is that, should the US
market continue to be volatile, the same may
be expected from Japanese equities. The opposing
camp's view is that over the past 8 years Japanese
consumers have been reluctant to part with their
hard-earned cash, because of their concerns
about rising unemployment and being discouraged
by falling prices in the shops. They are of
the opinion that the first phase of corporate
restructuring appears to have been completed
and unemployment has stabilised accordingly.
The weaker yen will reintroduce an element of
positive inflation to the shops thereby possibly
breaking the logjam in consumer spending. In
the US and Europe, consumer confidence started
to pick up about two years into the recovery.
This is where Japan is today. While there seems
to be an indication of some signs of recovery,
severe problems still exist and a sustainable
bull market in shares is not possible until
these problems are resolved. Valuation levels
are not high, but no immediate recovery is anticipated.
There are definitely 2 camps when it comes to
Japan. There is without a doubt enormous potential
growth in Japan, but as stated above there are
serious problems and we recommend viewing it
as a high - risk investment.
One view concerning South
Africa is that the economic recovery
remains on track - growth this year is expected
to match last year's estimated growth of around
3%. Likely tax relief possible in this year's
budget, the lagged impact of lower interest
rates and the weaker rand should underpin domestic
growth. There is currently a reasonable chance
of rate cuts later this year. The weak rand
is likely to provide the biggest support for
the domestic economy because it offers enormous
benefit to exporters, local companies competing
with imports and the tourism industry. A weaker
rand does, on the other hand, carry risks of
higher inflation. The dominant view is currently
that the South African Reserve Bank should reach
its CPIX inflation target of 3%-6% by 2002.
However, the economic recovery remains vulnerable
to both external and internal shocks that can
trigger off balance of payments problems, resulting
in the rand being pushed over the edge - this
would naturally increase the risk of interest
rate hikes. Recent events have again confirmed
that the balance of payments is the backbone
of the South African economy and remains vulnerable.
This situation is likely to continue until such
time as South Africa succeeds in renewing local
and foreign investor confidence in its future
and in its economy. Although prospects for the
year do not look marvellous because of uncertainties
and possible risks, the large-scale pessimism
towards South Africa should recover over the
course of the year, if global economic and financial
events remain on track. Other views are that
a reversal of petrol price hikes, together with
the easing of interest rate fears, should spark
a recovery in consumer confidence and thereby
reinforcing the recovery in domestic demand.
Their view is for a GDP growth rate of around
3,2% for the year. This view is based on the
assumption that the rand stabilises against
the US dollar and that oil prices remain "in
check". However, the recent Rand weakness
- if sustained - could threaten this scenario.
The two key drivers for equity
markets are interest rates and corporate
profitability. When both of these move in the
right direction (i.e. falling interest rates
and rising corporate profits) equity markets
have the perfect scenario. However, if one is
positive and the other negative, equity markets
can still make good returns but with less certainty
due to market volatility. The year 2000 saw
corporate profits failing to meet expectations
and rising interest rates. Interest rates are
now in decline in the USA and companies are
likely to project more realistic profit targets
for the year ahead. Expectations are high that
both the UK and Europe are likely to reduce
their interest rates in the short to medium
term. The prevailing view is that the USA will
not slump into recession - but if it does then
the outlook for all markets will be negatively
affected.
Finally, from
an in-house point of view, we are of the opinion
that it is unwise for clients to attempt to
time the markets. For market timers, the fact
that the best and worst days often come close
together only adds to the chances of getting
it wrong - often with serious consequences.
We believe that investors can minimise the risks
associated with timing by remaining fully invested
in solid fund management companies who have
the expertise and resources to meet these challenges.
This report is based on information sourced
from various institutions, both local and international.
The report reflects a variety of views and is
not intended to convey investment advice. Please
consult us to obtain specific advice relevant
to your investment portfolio. 
