Global outlook for '07 says equities 'the place to be'

With 20% of global GDP, 20% of global oil consumption and 60% of the global consumer market, and being the world's sole superpower, the US is still the tail that wags the dog.

By AARON LEITNER
Our view for 2007 is that equity markets will still outperform bond markets. With 20 percent of global GDP, 20% of global oil consumption and 60% of the global consumer market, and being the world's sole superpower, the US is still the tail that wags the dog. Hence, as goes the US economy, so goes a good part of world economies. That being said, it is our view that the US is in an economic turnaround stage that should demonstrate clearer visibility in 2H 2007. There are several considerations to support this view. Last year, we witnessed a pronounced slowdown in the US real estate market (primarily in the residential section), Fed rate tightening that ended only in August and rising oil prices through most of the year. An economic slowdown set in and concerns over a US economic recession and doomsday scenario for the US dollar (primarily over concern that China would unwind its huge holdings in the currency) became the talk in financial markets. Now, early in 2007, it appears that the recession scenario is fading and that certain trends are gaining ground. The USD and the economy appear to be on a rocky road to recovery supported by a declining trade deficit, significantly reduced energy demand coupled with lower oil prices, a bottoming of the real estate market and continued low unemployment levels. Economic growth can be expected to be under 3%, down from 3.3% in 2006. The Fed is likely to stay in a holding pattern for the near-term, maintaining rates at 5.25% as it continues to monitor the effects of its 17 prior interest rate hikes on the economy. Regarding the USD, major concern has grown over China's huge USD reserves and desire to reduce its exposure. We believe that China does not believe that it is in its interest to take actions that could result in a stampede out of the USD, causing a dollar crash and US economic tailspin since the Chinese have a vested interest in a healthy US economy. Though China is already a major economic force, the fuel for its economic growth is the US consumer market. As they say, "Don't bite the hand that feeds you." We think that the Chinese well understand the symbiosis of this bi-lateral relationship. In the late 80s, the same scenario of concern was expressed regarding Japan and its huge USD reserves, and for the same reasons mentioned above, the Japanese continued to hold their US treasury debt. Europe's dependence on the US economy is not as profound as other regions of the world. Much of Europe's economic growth, in 2007, can be expected to be driven by domestic forces. We expect another year of healthy M&A activity and that pent up consumer demand, which was released in 2006, will continue to contribute to the continent's economic growth in 2007. Continued inflationary pressures may compel the ECB to raise hikes to 3.75% by the second half of the year. Both European and British economies are expected to maintain reasonable growth, though less than 2006's 2.7% & 2.5%, respectively. We believe that European equities will outperform the US markets. The direction of Japan's economy is a bit of a conundrum. Conflicting economic data vacillate between lack of clear direction to indications of an improving economy. The Bank of Japan and Finance Ministry are frequently finding themselves at odds over interpretation of economic data releases and policy. Initial signs indicate that upward wage pressures and increased corporate and government capital expenditures will contribute to economic expansion in 2007. The Japanese household is expected to have an increased influence on the economy and equities markets. Though we believe that Japanese equities will be attractive, the question is what will be the level of policy cooperation between the BoJ and the Finance Ministry and its impact on the economy. Although some emerging market countries are not so "emerging" anymore, and domestic consumer demand is a growing contributor to these nations' GDPs, the health of the US economy is still the linchpin that stimulates these markets' economies. In view of the expectation of continued US economic expansion, albeit at a moderate pace, we expect emerging markets to outperform. The emerging markets are expected to achieve a +6% GDP growth rate for 2007. China & India are projected to experience 9.8% and 8%, respectively. As for bonds, yield spreads have tightened in emerging and high-yield markets, reducing their attractiveness in 2007. We do believe that investment opportunities still exist in emerging market debt, though on a more selective basis. We expect little appreciation in bonds for 2007. The Australian dollar and GBP bond markets are more attractive against their US, European and Japanese counterparts. Though high-yield markets did well in 2006, softening economies increase the risk versus potential return in these investments. We still maintain a bias towards emerging market debt. Major world currencies are expected to head into various levels of resistance. Potential rate hikes by the European, UK and Japanese central banks, coupled with the desire of central banks to reduce their dollar holdings, may contribute to continued weakening of the USD. The euro may have reached full value and its current price reflects anticipation of another rate hike by the ECB. The GBP and the AUD are viewed favorably against the EUR for 2007. We are neutral on the USD. Looking at alternative asset classes, reduced global economic growth and demand for oil will continue to keep a cap on oil prices for 2007. Though some price increase can be expected, barring a major international crisis (i.e. - military action against Iran), OPEC can be expected to cautiously implement limited production cutbacks to avoid causing a global economic recession. As the threat of global inflation seems benign for 2007, gold is not likely to see its 2006 high anytime soon. Copper prices, on the other hand, are expected to climb as demand (primarily from China) continues to outstrip supply. Global real estate markets are expected to continue to provide attractive returns as they did in 2006. Main contributors will be continued M&A activity in this sector and major activity in REIT IPOs due to regulatory changes primarily in Europe. Our conclusion? The name of the game is still equities for 2007. The writer is the Global Investment Strategist at Tandem Capital