Article date: 7 December 2006
Economist StewartRobertson outlines prospects for economy andmarkets
- UK economy is in good health
- House prices will not crash
- Further stock market gains in 2007
Outlook for globalequities
After three years of exceptionally goodreturns, stock markets are expected to make further modest gainsin 2007 and returns of 6-10% look plausible.
- Companies around the world are generating plenty of profitsand investors are benfitting from strong dividend growth andsignificant share buybacks.
- Equity valuations still look reasonable, in contrast to thelate 1990s. Average price/earnings ratios are currently about12 to 16; in the late 1990s they were typically well above 20.
- Corporate finances are generally in good shape: cash levelsare high and debt levels are much lower than the late 1990s.
Bondyields are higher than the recent cycle lows but do not offergreat value. Although inflation should remain under control andfears of outright deflation have dissipated, yields around theworld still look too low. With little likelihood of a globalrecession, yields look unlikely to fall much further, whichimplies disappointing returns for investors.
Outlook for the UK
Inflation: The Bank of England raised interest rates inNovember to 5% and we anticipate that they will rise once more inearly 2007 to reach 5.25%. Inflation is above target and may risefurther. The Bank of England is concerned that higher inflationwill lead to higher wage demands over the key winter payround.
House prices: The UK housing market goes fromstrength to strength, both in terms of activity levels andprices, 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 doubledigits in early 2007. The housing market looks set to remainstrong for some time, and we do not believe there is much chanceof a big fall in house prices. The strong housing market shouldsupport retail sales in 2007.
Labour market: Unemployment is rising, but thishas been caused by rapid growth in the labour supply rather thanweakness in the demand for labour. In short, the number ofworkers looking for work is growing faster than the number ofjobs being created, partly because of large-scale immigration.Jobs growth has averaged about 1% since the mid-1990s, equivalenttoday to 250,000 to 300,000 net new jobs a year. But a rise inthe labourforce of 530,000 over the last 12 months has increasedthe jobless total.
Outlook for the US
The US economy isslowing as the housing market cools and spreads to the retail andmanufacturing sectors. The economy is growing more slowly thanusual but there are several reasons to be optimistic. Companieshave plenty of cash and are investing and hiring. Consumers arestill 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 ishigher than the Fed would like but is expected to fall back infirst half of 2007. The slowdown will persist in early 2007, butlower US interest rates next year will support a recovery.
Outlook for Europe
Economic growth hasimproved but will slow again in 2007. Eurozone growth slowed inthe third quarter of 2006, and weak consumer spending in Germanyis likely to be made worse because the country is about toexperience one of the biggest tax increases ever seen. There areunfortunate parallels with the Japanese of 1997 where tax risescondemned Japan to years of economic misery.
Inflation is below target but the European Central Bank isconcerned that it could push higher in early 2007, partly becauseof the increase in German VAT. Many of the Eurozone economies– Germany and Italy in particular – will see theirpopulations shrink significantly in coming years. This willreduce demand and output growth in the future.
Outlook for Japan
The Japanese economy isfinally recovering from the problems of the 1990s, but there isstill too much optimism about prospects for growth. The Japaneseeconomy will grow in 2007 but more slowly than most commentatorsthink. The economy still depends heavily on exports and will beaffected by slower world growth. Domestic growth will be limitedby falling population levels for decades. Deflation is ending ashouse and land prices start to rise. However, interest rates willincrease only very slowly.
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