The global markets picture

- compiled from information supplied by UBS


US housing weakness did indeed rock financial markets in 2007. The resulting sub-prime mortgage collapse and the liquidity and credit crises are starting to depress corporate earnings growth, especially in the financial and consumer sectors. While a protracted phase of below-trend growth in the US is expected, some analysts believe that a US recession is still avoidable.

The US Federal Reserve, which began cutting interest rates in September, is acting to prevent a broadening of the financial market disruptions to the economy, and interest rate cuts are likely to continue. Mitigating factors against recession are the very high cash flow levels of US companies relative to total assets and their healthy debt ratios.

Although economic activity throughout much of the rest of the world is in better shape, global growth is likely to have peaked and should be less swift in 2008. However, continued strength in emerging market economies will be likely to prolong the solid expansion in the world economy.

Large cap equities offer the most opportunity: Large cap developed equities are poised to perform well in 2008 and offer significantly better growth opportunities than smaller cap stocks. While stocks may struggle early in the year due to adverse news from the US housing, mortgage and consumer sectors, once growth worries recede, as is expected, the equity market environment should improve.

US and Europe are preferred: European and US stock markets are positioned to hold up better than other regions, where it is expected to be more difficult for companies to sustain earnings growth. This is because a large number of companies listed in the US and Europe have global operations and earn their profits in more than one region. Price-to-earnings ratios are also significantly below historical averages, which bode well for future performance.

Emerging markets: Be selective Strong economic growth in emerging market countries will be likely to continue to provide a good underpinning for emerging market stocks. However, the strong performance of the past few years has led to increasingly stretched valuations when compared to developed market equities. Thus, it is important to be more cautious on the outlook for emerging market equities.

Bond markets expected to struggle: Bonds offer weaker prospects than equities for 2008. While the fixed income markets may find some support in the near term because of disappointing macroeconomic news out of the US and other economies, economic growth later in the year and the rise of inflation expectations as a consequence of the US Federal Reserve’s easing stance can place upward pressure on bond yields.

US government bonds are likely to deliver sub-par returns and corporate bonds should also struggle this year. Although last summer’s credit market downturn has brought corporate bonds back closer to fair value, deteriorating credit fundamentals limit the potential for corporate bonds to outperform government bonds. The most value is seen in investment grade bonds rather than high yield.