FYI | May 23 2006
By Chris Shaw (Tokyo)
If the recent correction in equity and commodity markets isn’t enough by itself to make investors feel a little (or very) uneasy, consider this fact – the last time markets corrected significantly in response to fears over higher interest rates was in 1987.
As ABN Amro points out though a repeat performance is less likely in 2006 as there are a few differences between what happened in October of that year and what is happening now.
Firstly, the broker notes in 1987 the US dollar had largely completed its fall against other currencies, as by the time of the stockmarket crash it had dropped about 25% in trade-weighted terms. In contrast, with the current concerns over the twin deficits in the US, it appears the greenback is still in the early stages of a correction.
Secondly, inflation is not yet the problem that it was in 1987, particularly as growth in Europe remains relatively subdued and inflationary indicators in the US, while moving higher, are not yet at dangerous levels.
The broker acknowledges history could repeat itself if central banks decide against lifting interest rates to keep inflation under control and to slow growth, but it doesn’t think such an outcome as likely.
As a result, it has maintained its stance of being long equities and short bonds, a trade that looks even more attractive given equity valuations have come back to earth a little in the past few sessions.
Given the global nature of the current correction, the broker also suggests some emerging economies such as Brazil and parts of Asia are looking more interesting, so taking positions during the current weakness could prove a good move. Adding to positions in European equities is also likely to prove profitable in its view, as it expects the European markets to outperform bonds and most other equity markets thanks to rising earnings.