Investment Strategist Gerard Lane outlines the prospects for investment markets
Investment Strategist Gerard Lane outlines the prospects for investment markets
Background
Record company profits and stable interest rates makes life for investors almost as good as it gets. After a short sharp sell-off in October, markets have stabilised. With oil prices easing and the housing market recovering, there are reasons to be optimistic about the prospects for the rest of the year. However, public sector finances are likely to remain challenging and there is the risk of tax rises at some point over the next two years.
Norwich Union expects that growth will extend into 2006. US activity appears to have recovered following hurricanes Wilma, Rita and Katrina. Further economic recovery in Japan, strength in China and broadening European economic activity should mean that the world becomes less dependent on the US for growth, even though the absolute level of economic growth through 2006 may moderate.
Global inflation pressures are likely to rise and the outlook for interest rates is mixed. Further increases in the US are likely, while initial monetary tightening from the ECB and Bank of Japan may come through in 2006. The Bank of England is faced with a rise in inflationary risks while economic growth moderates. As further evidence of resilience and recovery of the UK consumer emerges over the next few months, there may be pressure for the Monetary Policy Committee (MPC) to raise rates, but for now UK interest rates are likely to remain on hold.
Equities
- UK investors have enjoyed a third year of positive returns from global equities. The strong recovery in profits since 2002, attractive valuations combined with low and stable interest rates have provided an excellent equity environment.
- Interest rates around the world are likely to rise in 2006, and profits growth may slow. This is likely to make equity returns more modest than that enjoyed in 2003-05. However, attractive valuations and strong corporate finances make equities the asset class of choice.
- US equities have underperformed over the last few years, as cyclical, higher-risk, markets such as Germany and Asia have performed well. This has meant that the clear valuation advantages that non-US markets had, have receded. As a result US equities may start to outperform, especially as profits growth moderates globally.
Bonds
- Bond markets have performed well over the last 10 years as inflation expectations have fallen and interest rates remained low and stable. 2005 has been the first year since 1999 where inflation expectations have risen and caused bond yields to rise.
- As cyclical inflation has emerged, interest rates have increased causing bond yields to rise. The risk of further inflation remains and as such bonds are not yet attractive, despite the higher yields. If 2006 proves to be a year of economic growth moderation, then US bond yields close to 5% would appear attractive.
- Corporate bonds have also benefited from the corporate sector repairing its balance sheet. Record corporate profits have resulted in a large scale of paying down debt. As a result corporate bonds are perceived as having less default risk, and spreads over government bonds have narrowed.
- If companies follow the traditional economic cycle and engage in investment and mergers and acquisition activity, investors could expect the borrowing to increase. As a result the excellent environment for corporate bonds may worsen slightly over the next few years.
-ends-
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Notes to editors
- Norwich Union is one of the UK's biggest insurers. It is a leading provider of life and pensions products and one of the largest Financial Adviser (FA) providers. FAs provide over 70% of the company's long-term savings business in the UK.
- Norwich Union has strategic alliances with building societies and other leading UK brand names including CIS and The Royal Bank of Scotland Group. Norwich Union’s news releases and a selection of images are available from Aviva's internet press centre at www.aviva.com/media.