BT: Benign outlook for 2007 (05 Feb 2007)

Benign outlook for 2007

After the excitement of record highs in 2006, not just for emerging markets but also the Dow Jones, Hang Seng and STI, some investors fear 2007 may be a letdown. Not so, say Citigroup's global analysts. Daniel Buenas reports.

AS February rolls around and the new year kicks into full gear, perhaps it's time to take a look at what 2007 could hold.

The Singapore market has been moving ahead at full steam, but will the bull run continue, and how will other global equity markets perform?

Over the next few weeks, we get advice from Citigroup analysts and examine how they think 2007 will fair, in terms of developed and emerging market equities, global bonds and currencies, and alternative investments.

In a report entitled 2007 - On track for stable economic growth, but will markets continue to rally?, Citigroup analysts note that global equity markets had a fourth year of consecutive gains in 2006, in defiance of sceptics.

''Looking back to January 2003, the MSCI World Free Index has risen about 85 per cent cumulatively, compared to about 27 per cent for global government bonds and about 10 per cent returns for US dollar-deposits,'' the report says.

However, can this outperformance continue for another year, especially given that both US and European economic growth are expected to ease in the months ahead?

''There is a growing worry that the 2007 markets could have some nasty surprises up their sleeves,'' the report says. ''Yet, current indicators suggest otherwise. In particular, short- term interest rates in most developed countries appear likely to show relatively little movement.''

According to the report, except for Japan - where rates are forecast to rise more quickly given their current very low levels - short-term rates in the US should fall minimally in the second half of this year, with rates in the euro-area also expected to remain unchanged until late 2007.

Add to this reasonable developed market valuations, limited inflationary pressures, sound company balance sheets and good risk appetites, and you end up with what Citigroup analysts term a ''benign outcome for financial markets''.

''This means that although equity markets are unlikely to match the 20 or 30 per cent rises typical of a recovery phase, very few factors are thought to exist that could derail the global equity market from its long-term annual average of between 8-10 per cent,'' the report says. ''Like long distance runners, equity markets in 2007 are expected to settle into a steady, but sustainable pace.''

Additionally, some of the opportunities that arose in 2006 have not all been fully realised, which could augur well for investors in 2007.

Citigroup analysts point out that US equities have underperformed other equity markets, and the overly-bearish consensus views of US corporate earnings leave room for some ''pleasant surprises''.

''It is also interesting to note that unlike previous rallies, the US and European markets over the past two years have not been driven by rampant retail buying, but by corporate activity outside the public equity market,'' the report says. ''While this spate of share buy-backs and mergers and acquisitions is expected to continue, more equity interest from retail and institutional investors could help to give the markets that extra push.''

But, while things should continue to look up, there is no room for complacency, the report says, adding that strong year-end rises in 2006 may give way to some short-term volatility early in the year.

''Over the longer term, investing can be made less stressful if steps are taken to add buoyancy to a portfolio in the event of unforeseen ice-bergs,'' the report says.

Citigroup analysts recommend that investors should construct their portfolios by taking into account two distinct parts. The report says that, on the one hand, emerging market equities, commodities and other single sectors or country investments can help boost portfolio returns - so long as their risks and short-term opportunities are well understood. (insert chart)

On the other hand, global and developed market equities, diversified real estate investment trusts and certain multi-style, multi-manager hedge funds can act as both portfolio stabilisers and long-term wealth generators through their regular rental and dividend streams.

''Bonds do the same by paying a regular income and enjoying capital upside in less positive economic environments,'' the report says. ''By combining these investment types optimally, a portfolio, like a well-built machine, can prove to be greater than the sum of its parts.'''Like long distance runners, equity markets in 2007 are expected to settle into a steady, but sustainable pace.'

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