26 January 2004
As we enter the Chinese Year of the Monkey, stock markets around the world have been behaving as sprightly as the animal after which the year is named. In fact, most analysts have been expecting stock prices to appreciate in 2004. However, in a Year of the Monkey, investors may need to be prepared for some unexpected mischief.
Market folklore says that a gain for stocks in January is a positive sign for the rest of the year. Well, most major stock markets around the world have made positive starts to 2004, as shown in the table below.
|
|
Close on |
Close on |
Percentage |
|
Standard & Poor's 500 |
1,111.92 |
1,141.55 |
2.66% |
|
Nikkei 225 |
10,676.64 |
11,069.01 |
3.68% |
|
Hang Seng |
12,575.94 |
13,750.58 |
9.34% |
|
Straits Times |
1,764.52 |
1,889.56 |
7.09% |
|
Note: For Hong Kong and Singapore, closing date is 21 January as both markets were closed on 22 and 23 for the Chinese New Year. |
|||
There is still one week left to go in January, but the odds favour a positive close for the month. So if the folklore proves correct, there is still further upside potential in stocks.
In fact, most analysts predict as much. A BusinessWeek survey last month saw analysts forecasting the S&P 500 to end 2004 at a mean level of 1,166. A recent annual survey of investment managers by Mercer Investment Consulting found that the managers on average expected the Morgan Stanley Capital International World Index to rise 8 percent in 2004 and the Emerging Markets Index to rise 12.5 percent.
What is interesting, though, is that if the forecasts are correct, most of the markets have already seen most of their gains for the year. Some analysts see a slowdown in the world economy towards the end of the year or early next year as the effects of the fiscal stimulus from US budget cuts dissipate, and expect stock prices to slow down as well. Others expect rising interest rates to cause P/E multiples to contract and offset earnings growth.
Indeed, at the forecasted S&P 500 year-end level of 1,166, US stocks would be trading at about 19 times 2004 earnings. With earnings deceleration looming from then on, that is not a cheap valuation.
The sectors favoured by analysts largely reflect their level of optimism. Industrial and technology stocks are favoured by the more optimistic analysts, health-care and consumer staples by the less optimistic ones. Some suggest a bit of market timing, rotating out of the former sectors and into the latter sectors around mid-year as the bull gets tired.
However, if the more extreme pessimists are correct, investors would do better to get out of stocks altogether. The risks to the world economy are not insignificant. They include terrorism, US dollar weakness, a rise in interest rates and record levels of US debt.
In fact, the last three – each of which is a risk in its own right – are also interrelated. A weaker US dollar means that the US has to increase the price it pays for foreign savings. In other words, interest rates go up. Higher interest rates discourage consumers and businesses from taking on more debt, and may even cause some to attempt to repay debt. In either case, spending – both consumer and business – would be negatively affected, which would in turn pull down the economy.
The alternative is for the US Federal Reserve to keep monetary policy loose to keep interest rates in check. The risk in this policy is that the US dollar may go into a free fall. Foreigners would baulk at continuing to subsidise the American consumer by holding on to a depreciating currency without the compensation of higher interest rates.
So US economic policy-makers are caught between a rock and a hard place. Ideally, to sustain the ongoing economic expansion, the world should look for alternative sources of demand.
Unfortunately, at the moment, it is not very clear where these should come from. Demand in Europe and Japan is weak, while Asia is already swamped with excess manufacturing capacity. Even China, the economic superstar of 2003 with GDP growth of 9.1 percent, has tightened credit to rein in over-investment.
Therefore, investors buying on the rosy scenario being painted for the world economy in 2004 need to keep in mind the risks. Should markets turn down subsequently, those who manage to keep or – better still – make money in this Year of the Monkey would then be able to enter 2005, the Year of the Rooster, with something to crow about.
Disclaimer: The commentaries posted here represent the opinions of the author at the time of posting and should not be taken as investment advice. Readers who wish to take any investment action based on information obtained from this site should seek appropriate advice from a qualified financial adviser.