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Global Markets Weekly
28 May 2010

• OECD’s upgraded forecasts are a timely reminder of positive underlying fundamentals.
  While news of the OECD’s upgraded growth forecasts was dismissed by some commentators as having been overtaken by events, it coincided with a bounce from the recent sell-off in risk assets. In any case, the revision to 2.7% 2010 growth for the OECD group, from a 1.9% November estimate, was a timely reminder that outlook is still significantly better than expected just six months ago, despite the euro-zone debt crisis and political headwinds. We do not think the euro-zone fiscal crisis will do lasting damage to the US or Asia, and consequently we believe risk assets remain fundamentally attractive.
• Corporate results are beating estimates and showing top-line growth.
  A combination of better-than-expected results and top-line growth should also support equity markets, despite concerns about the health of the euro-zone. With 73% of first-quarter (Q1) earnings having been published, our aggregate model indicates that roughly two thirds of the 1483 companies reporting have beaten analysts’ forecasts. Earnings have grown by an average of 28.5% from Q4 2009, with a particularly encouraging 9.1% increase in sales, implying that earnings growth is not solely attributable to cost cutting.
• The US is not like peripheral Europe, and won’t be forced into fiscal tightening.
  With the euro-zone debt crisis pushing member states to undertake involuntary fiscal tightening in recent weeks, the markets had started to price in higher risk of a forced rapid fiscal consolidation in the US. Although the US budget deficit is comparable and individual states are facing debt crises, the market, economic and political systems are different. We do not expect the bond market to force the US into a severe fiscal tightening, but rather see a voluntary and gradual fiscal consolidation following the November mid-term elections. We forecast slowing US growth later this year, but expect it to remain superior to the rest of the developed world. This is a key to our cautiously positive view on global growth and our preference for US equities.
• EU problems mean less growth and lower inflation…
  With Italy joining Spain, Portugal and Greece in significant budget cuts and Germany expected to reveal new measures imminently, our forecasts of a double-dip for most of the ‘sinner’ countries with high deficits are increasingly credible. The euro-zone as a whole is likely to avoid recession, helped by the boost to exports from a weaker currency, but a lack of growth means that inflation will be weak. Initial inflation figures from German states showed little change at 1% for April. This supports our view that conventional, fixed-interest sovereign bonds will continue their recent outperformance versus inflation-linked bonds, as both real yields and inflation expectations have fallen.
• …but lower inflation is good news for emerging markets.
  While emerging markets are highly geared to global growth, through exports and commodity prices, the recent euro-zone clouds over growth are not without a silver lining. Fears over monetary-policy tightening have hung over Asia equities this year as many countries, including China, were showing clear signs of overheating. A slight moderation of growth and lower commodity prices will remove some inflationary pressures, providing a more positive outlook for these markets. Similarly, we would be positive on the currencies of exporters like Australia and Canada, as their government finances are in good shape and they offer either a higher yield or prospects of rate increases.

Indices, Interest rates and Inflation

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