Globally, Stocks Are Poised to Advance Further
By ERIC PFANNER
International Herald Tribune
LONDON
DESPITE the strongest global economic growth since the 1970's and outsized gains in corporate profits, 2004 was a decidedly ho-hum year for international stock markets, which took their cues from Wall Street. So, what will happen this year if, as expected, growth and profits ease back toward more normal rates?
Stock prices could actually forge ahead solidly, if not spectacularly, market strategists say. Average gains of 10 percent or so are expected globally, and some regions, including Continental Europe, could do a bit better. And if the dollar declines further, as many analysts expect, American investors who put some of their money into overseas securities might do even better, once currencies are converted. It is not that investors are returning to the irrational exuberance of the late 1990's - or even the milder wave of post-bubble optimism that washed over many global markets in 2003. But stocks in some regions remain attractively priced, at least relative to bonds, analysts say.
"We're not gung-ho, we're realistic," said Richard Batty, global investment strategist at Standard Life Investments in Edinburgh. "But markets generally have been pricing in a more pessimistic outlook than we think is warranted."
Many global stock markets finished 2004 above where they started, but not spectacularly so. In Japan, the Nikkei index was up only 7.61 percent, despite an improved economic outlook. Morgan Stanley Capital International's index showed a better gain in Japan - 10.9 percent, and for Americans who converted their yen-based gains into dollars, the rise was 16 percent. In Europe, stocks generally posted slightly larger gains, even as growth continued to be disappointing. In China and in Russia, stocks showed little change at the end of the year, despite strong economic growth. Morgan Stanley Capital International calculated a 2 percent rise for China.
The best performances were in emerging markets that benefited from a surge in commodity prices, particularly in Latin American markets like Mexico and Peru, and in some secondary European markets, including Iceland, Belgium, Norway, Austria, Hungary and Romania. Because of the fall in the dollar that accelerated toward the end of last year, American investors who ventured into foreign stock markets did considerably better than investors who used the local currencies. A local investor in the euro zone, for instance, would have seen gains of only 13.3 percent, based on a Morgan Stanley Capital International index of the region; in dollar terms, the return was 22.4 percent.
Morgan Stanley strategists predict gains of 8 percent in European stocks next year, based on share prices in mid-December. They see solid double-digit gains in Japan, with the Topix index, which finished 2004 at 1,149.63, rising to near 1,300 by the end of this year.
At Lehman Brothers, analysts are less enthusiastic about Japan, but see comparable gains in Europe. With dividends reinvested and including the effects of an additional 5 percent drop in the dollar against the euro, which they predict for this year, gains for American investors in euro-denominated shares could reach double digits. Other analysts, too, point to the euro zone as one of the most promising areas for share price growth.
To be sure, the dollar is one of several variables that make predicting share prices as dicey as ever. If it continues to fall, as many analysts expect, given the size of the United States' current account deficit, that could put upward pressure on inflation, prompting the Federal Reserve to raise interest rates more aggressively than it did in 2004. A weaker dollar could also lead to a renewed increase in oil prices, because oil is traded globally in dollars.
Though oil prices eased in December, ending the year at $43.35 a barrel, after passing $55 in October, a combination of continuing high prices and tighter monetary policy in the United States might slow global economic growth by curbing American demand for imports. Economists generally expect global growth to ease from rates near 5 percent last year to 3.5 percent to 4 percent this year, with a slight uptick in inflation. The combination makes some analysts wary about prospects for global stock markets.
"We've moved from above-trend growth and below-trend inflation to above trend in both," said Tim Bond, a strategist at Barclays Capital here. "That's negative for almost every asset class, except perhaps commodities."
Nonetheless, investors seem to be prepared to give stocks a chance. A Merrill Lynch survey of global fund managers in December showed that 77 percent expected equities to do better than bonds or cash this year. The managers were particularly bearish on bonds, which fall in price when interest rates are on the rise.
Continued strength in corporate earnings should provide some support for share prices, analysts say. Last year, companies in the United States, Europe and even Japan reaped the benefits of several years of cutting costs. As strong economic growth drove demand higher, profits of companies in the MSCI All-Country World index, a broad gauge of global stock prices, were on track for an annual increase of 25 percent, analysts at Morgan Stanley said. This year, they expect less impressive gains of 8 percent, just above the long-term trend of 7 percent.
Given that Europe has borne the brunt of the dollar's slide, with a rising euro making the region's exports less competitive, analysts' relative optimism about European stocks may seem surprising. But euro zone stocks are priced attractively, with price-to-earnings ratios around 14 percent, compared with about 16 percent for stocks globally.
European corporate profits are also expected to hold up fairly well, despite the strong euro. Companies seem to be suffering less than might seem likely, given policy makers' noisy laments about the weak dollar.
There are several reasons for this. European companies, like their American counterparts, have grown extremely frugal about capital expenditures, after the spree of the bubble years. And, particularly in Germany, long known for high labor costs, several big manufacturers have cited the threat of low-wage competition from new European Union members in the east and won concessions from workers.
Overall, hourly labor costs in the euro zone grew by only 2 percent in the third quarter of 2004, compared with a year earlier, the lowest increase since 1998.
"The unions seem to be getting more pragmatic," Mr. Batty said. "They realize things are changing. From a stock market point of view, this is great news."
As always, optimism about Europe needs to be tempered, analysts say. Some worry about the effects of a shift to new international accounting standards, which is required for all publicly traded companies in the European Union by the end of this year. One result could be increased volatility in reported earnings.
And the euro zone economy, which analysts at ABN Amro say will grow by only 1.5 percent this year, after 1.8 percent growth in 2004, could slow even further, particularly if consumer spending continues to stagnate.
Possible weakness in consumer spending could also hurt Britain, which remains outside the euro zone and has enjoyed several years of strength compared with its neighbors. Analysts worry that a boom in housing prices, which has fueled consumer spending, may be over, with prices already easing slightly in recent months. Nevertheless, most analysts are optimistic about the outlook for British stocks, which were rising at the end of last year, bolstered by banking issues.
Many analysts expect the Japanese economy to slow, too, after a solid 2004; Morgan Stanley predicts 0.5 percent growth, after 4 percent last year. That makes many strategists wary about prospects both for Japanese stocks, which have not drawn much strength from improved corporate finances, and the overall economy after more than a decade of recessionlike conditions.
Some analysts, however, see an opportunity in Japan for patient investors. A slowdown in the growth of corporate profits - analysts expect that once the numbers are in for 2004, they will show profit growth of 60 percent - seems inevitable, but it will not prevent a longer-term recovery from taking hold. "We think the market will begin recognizing that Japan has taken the first step toward returning to normal," said Naoki Kamiyama, a strategist at Morgan Stanley, in a note to investors.
Elsewhere in Asia, all eyes remain on China. A mild slowdown in that country's runaway growth rate, and a possible easing of the currency's tie to the dollar, could put pressure on shares, which performed poorly last year. Analysts say other Asian markets, particularly those with heavy exposure to technology stocks, like South Korea and Taiwan, might do better, though.
And other emerging markets, especially those that have benefited from a global surge in commodity prices, could continue to power ahead, strategists say. Many South American markets, for instance, have enjoyed a period of relative political and financial stability, and resource-rich countries like Brazil have fared particularly well.
Over all, said Mr. Bond at Barclays Capital, "equities globally are well placed against bonds, but it will be a year of modest returns."
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Prudent Investor says: Not so fast there...most of these analysts are talking from the rear view mirror perspectives, in other words using the immediate past as a measure to predict future performances. Caveat, dear readers.
According to several leading multilateral institutions such as the OECD and World Bank, the prospects of slower economic growth for the world are more likely in 2005, as to how much of that could be equated with gains in the global equities and more so in the commodities (some, not all) front is something to be reckoned with, unless of course we could see some foreign currency reserve rich Asian nations picking up the consumer demand and domestic investment slack caused by the anticipated global softening. But of course, economics is not the sole determinant, liquidity is likely a more influential factor. With global Central Banks likely to follow on the footsteps of the US Federal Reserve in its 'measured pace' of monetary tightening, the odds are stacked in favor of a 'lesser' optismistic outlook for the major equities and bond markets compared to these 'mostly' pollyannaish mainstream forecasts.
It will be a challenging 2005 indeed. Care to place your bets?
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