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Strategic Outlook 2008: A Rocky Ride
Here at the beginning of 2008 the uncertainty about the development in the financial markets has not been higher in several years. This uncertainty has resulted in falling equity prices, lower yields on long-term government bonds and widening yield spreads. The uncertainty has been fuelled by concerns about a recession in the US as well as continuing turmoil in the banking sector and the money market.
In our assessment there is no indication that the uncertainty will disappear in the short term. Concerns about a recession the US may continue for quite some time into H1. Nervousness about further announcements of losses on the part of banks may trouble the markets. In that respect the housing market in the US, in respect of the risk of rising unemployment and falling house prices, is very important. Undoubtedly, this theme will not be exhausted in the short term. Moreover, we will see some uncertainty with respect to the development of the companies' earnings. Finally, the slowdown in growth in the US may result in concerns that the slowdown in growth may spread to the rest of the world.
The uncertainty has triggered reactions on the part of various monetary and fiscal authorities. The major central banks all over the world have attempted to calm down the turmoil in the money market by injecting additional liquidity and the money-market rates have fallen.
However, the spread between the moneymarket rates and the central-bank rates are still wide, as appears from the chart below. Most likely the spread reflects distrust on the part of the banks, and to a great extent the central banks do not have much power over these banks. This distrust will not disappear until we get a better idea of the potential losses in the financial sector.
The US central bank has been the most aggressive player to combat the turmoil. It has already lowered its interest rate by 1 percentage point and we may see further cuts. Also, the fiscal policy may be relaxed in the US, yet it applies to all these measures that they will have a limited impact on economic growth in H1.
Generally we expect that the difficult H1 will put a damper on investors' willingness to invest and thus also on the financial markets. We recommend that investors are cautious at the beginning of the year.
The prospects for economic growth in H2 are brighter as the Fed's interest-rate cut will begin to be reflected to a greater extent and housing construction is expected to stabilise. This will reduce uncertainty, and it is expected that the improved growth prospects will lead to stronger risk appetite on the part of investors.
Generally we expect an uncertain H1 in the financial markets, but this period will be followed by a more positive H2. It is expected that equity prices will recover and rise by 5-10% over the year. Also, we predict generally higher long-term yields and it is on the cards that the US dollar will strengthen. Finally, chances are that we will see decent returns on EM and commodities, while prospects are a bit more subdued with respect to corporate bonds.
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