Norwich Union's investment market outlook for 2006

Article date: 5 December 2005

Investment Strategist Gerard Lane outlines the prospectsfor investment markets

Background
Record company profits andstable interest rates makes life for investors almost as good as itgets. After a short sharp sell-off in October, markets havestabilised. With oil prices easing and the housing marketrecovering, there are reasons to be optimistic about the prospectsfor the rest of the year. However, public sector finances arelikely to remain challenging and there is the risk of tax rises atsome point over the next two years.

Norwich Union expects that growth will extend into 2006. USactivity appears to have recovered following hurricanes Wilma, Ritaand Katrina. Further economic recovery in Japan, strength in Chinaand broadening European economic activity should mean that theworld becomes less dependent on the US for growth, even though theabsolute level of economic growth through 2006 may moderate.

Global inflation pressures are likely to rise and the outlookfor interest rates is mixed. Further increases in the US arelikely, while initial monetary tightening from the ECB and Bank ofJapan may come through in 2006. The Bank of England is faced with arise in inflationary risks while economic growth moderates. Asfurther evidence of resilience and recovery of the UK consumeremerges over the next few months, there may be pressure for theMonetary Policy Committee (MPC) to raise rates, but for now UKinterest rates are likely to remain on hold.

Equities

  • UK investors have enjoyed a third year of positive returnsfrom global equities. The strong recovery in profits since 2002,attractive valuations combined with low and stable interest rateshave 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 returnsmore modest than that enjoyed in 2003-05. However, attractivevaluations and strong corporate finances make equities the assetclass of choice.
  • US equities have underperformed over the last few years, ascyclical, higher-risk, markets such as Germany and Asia haveperformed well. This has meant that the clear valuation advantagesthat non-US markets had, have receded. As a result US equities maystart to outperform, especially as profits growth moderatesglobally.

Bonds

  • Bond markets have performed well over the last 10 years asinflation expectations have fallen and interest rates remained lowand stable. 2005 has been the first year since 1999 whereinflation expectations have risen and caused bond yields torise.
  • As cyclical inflation has emerged, interest rates haveincreased causing bond yields to rise. The risk of furtherinflation remains and as such bonds are not yet attractive,despite the higher yields. If 2006 proves to be a year of economicgrowth moderation, then US bond yields close to 5% would appearattractive.
  • Corporate bonds have also benefited from the corporate sectorrepairing its balance sheet. Record corporate profits haveresulted in a large scale of paying down debt. As a resultcorporate bonds are perceived as having less default risk, andspreads over government bonds have narrowed.
  • If companies follow the traditional economic cycle and engagein investment and mergers and acquisition activity, investorscould expect the borrowing to increase. As a result the excellentenvironment for corporate bonds may worsen slightly over the nextfew years.

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Press office contacts:
David Gwyer 01904 452828 Out of hours 07800 699508
James Evans 01904 452791 Out of hours 07800 699525
Rob Pell 01904 452659 Out of hours 07800 699563
Cheryl Cox 01904 452617 Out of hours 07800 695275

Notes to editors

  • Norwich Union is one of the UK's biggest insurers. It is aleading provider of life and pensions products and one of thelargest Financial Adviser (FA) providers. FAs provide over 70% ofthe company's long-term savings business in the UK.
  • Norwich Union has strategic alliances with building societiesand other leading UK brand names including CIS and The Royal Bankof Scotland Group. Norwich Union’s news releases and aselection of images are available from Aviva's internet presscentre at www.aviva.com/media.

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