Economist Stewart Robertson outlines prospects for economy and markets.
- UK economy is in good health
- House prices will not crash
- Further stock market gains in 2007
Outlook for global equities
After three years of exceptionally good returns, stock markets are expected to make further modest gains in 2007 and returns of 6-10% look plausible.
- Companies around the world are generating plenty of profits and investors are benefiting from strong dividend growth and significant share buybacks.
- Equity valuations still look reasonable, in contrast to the late 1990s. Average price/earnings ratios are currently about 12 to 16; in the late 1990s they were typically well above 20.
- Corporate finances are generally in good shape: cash levels are high and debt levels are much lower than the late 1990s.
Bond markets
Bond yields are higher than the recent cycle lows but do not offer great value. Although inflation should remain under control and fears of outright deflation have dissipated, yields around the world still look too low. With little likelihood of a global recession, yields look unlikely to fall much further, which implies disappointing returns for investors.
Outlook for the UK
Inflation: The Bank of England raised interest rates in November to 5% and we anticipate that they will rise once more in early 2007 to reach 5.25%. Inflation is above target and may rise further. The Bank of England is concerned that higher inflation will lead to higher wage demands over the key winter pay round.
House prices: The UK housing market goes from strength to strength, both in terms of activity levels and prices, partly because of the shortage in the supply of houses. House price inflation has picked up steadily over the last year. It is currently running at about 8%, and could reach double digits in early 2007. The housing market looks set to remain strong for some time, and we do not believe there is much chance of a big fall in house prices. The strong housing market should support retail sales in 2007.
Labour market: Unemployment is rising, but this has been caused by rapid growth in the labour supply rather than weakness in the demand for labour. In short, the number of workers looking for work is growing faster than the number of jobs being created, partly because of large-scale immigration. Jobs growth has averaged about 1% since the mid-1990s, equivalent today to 250,000 to 300,000 net new jobs a year. But a rise in the labour force of 530,000 over the last 12 months has increased the jobless total.
Outlook for the US
The US economy is slowing as the housing market cools and spreads to the retail and manufacturing sectors. The economy is growing more slowly than usual but there are several reasons to be optimistic. Companies have plenty of cash and are investing and hiring. Consumers are still willing to spend and interest rates are relatively low. Unemployment is expected to rise a little as the economy slows, but not by enough to cause a consumer meltdown. Inflation is higher than the Fed would like but is expected to fall back in first half of 2007. The slowdown will persist in early 2007, but lower US interest rates next year will support a recovery.
Outlook for Europe
Economic growth has improved but will slow again in 2007. Eurozone growth slowed in the third quarter of 2006, and weak consumer spending in Germany is likely to be made worse because the country is about to experience one of the biggest tax increases ever seen. There are unfortunate parallels with the Japanese of 1997 where tax rises condemned Japan to years of economic misery.
Inflation is below target but the European Central Bank is concerned that it could push higher in early 2007, partly because of the increase in German VAT. Many of the Eurozone economies – Germany and Italy in particular – will see their populations shrink significantly in coming years. This will reduce demand and output growth in the future.
Outlook for Japan
The Japanese economy is finally recovering from the problems of the 1990s, but there is still too much optimism about prospects for growth. The Japanese economy will grow in 2007 but more slowly than most commentators think. The economy still depends heavily on exports and will be affected by slower world growth. Domestic growth will be limited by falling population levels for decades. Deflation is ending as house and land prices start to rise. However, interest rates will increase only very slowly.
-ends-
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