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Thursday, 25th April 2024 |
I ’m always wary about making long term predictions. Naturally it’s good to take long term views, provided those reading them realise that they are dynamic not static. The predictions below therefore, should be considered as valid as at Christmas 1998 but subject to change, as advised in the monthly columns over the coming year.
Overall Position: The long term cyclical decline in commodity prices has been the key driver in many markets for most of this decade. The diminution of the inflation threat that this has brought, has allowed interest rates to tumble, which has in turn supported one of the best equity market runs in economic history. The overall deflationary cycle forms part of an approximately 60 year long ebb and flow in inflation known as the Kondratiev cycle. This cycle typically involves an initial economic expansion from the ashes of an economic collapse (on this occasion, the thirties depression) which is accompanied by a rise in prices. The momentum of these price rises peaks in mid cycle (the oil crises and precious metals bubble of seventies/early eighties). Later in the cycle, disinflation (moderated price inflation) is seen, often caused be over capacity. Ultimately deflation (falling prices) and monetary collapse complete the process.
The key question now is to what extent is this cycle different and thus whether the threat of deflation and monetary collapse can be avoided during 1999 and beyond.
This cycle has been marked by substantial technological advances, which in addition to overcapacity, have helped fuel the disinflationary process. Technological advances have also cushioned the US and Europe from the more negative aspects of the deflationary cycle by improving corporate profitability. The same cannot be said globally. Russia has undergone a collapse similar to that Germany underwent in the 1920s (at the same stage in the last Kondratiev wave). Japan has been in a decade long bear market and has set its lowest growth target for 1999 since WWII. The position of the former Asian tigers needs little comment.
Whether we in the West can avoid the global contagion is critical at this juncture. The extraordinary efforts of the IMF, Western Central Banks and Governments to plug the cracks during September and October 1998 highlight how bad the position really was. A systemic collapse was conceivable and was thankfully avoided for now.
Some slow down next year however, appears inevitable. Over capacity against a background of falling prices will hit many companies. Banks will continue to disentangle themselves from their more risky positions and have clawed back significantly their risk appetites. Both factors will put a brake on expansion in 1999.
Equity Markets: Against this background I am neutral on western equities. A range is likely in the US Market with containment between the September 1st low (7,400) and November 24th high (9,380) possible for all of 1999. A spike to new highs may accompany the January rush into markets but it should be short lived. I find it hard to build a case for levels over 10,000 next year. If anything, the risk is on the downside.
Asian markets perversely may be worth a look. Support near 12,000 on the Nikkei, if seen in Q1 of next year, would provide an excellent opportunity to enter this market. Equally the collapse in the Hang Seng this year may mark the low of this market for some time. A fall towards 9000 +/- 250 points would provide an excellent entry level.
Bond Markets: With the overall inflation picture benign, expect the general trend towards lower rates to continue. The best signpost is the US Treasury Bond market which broke out of a multi-year range in 1998 with the move over 122/06 in the futures market. Broadly speaking if 120 holds, the prospect for bonds is good. The strategy for 1999 should be to buy dips.
Commodities: As described at the outset, commodities were weak in 1998, especially oil and precious metals. We will see oil trade lower in 1999 especially as sanctions on Iraq are lifted (by non-US/UK oil importers). For this commodity at least however, 1999 may mark its final low. Gold retains the potential for sharp rally towards $340/350. This seems likely (perhaps alongside a final T-Bond blow-out to 120/122 again) before deflation returns with a vengeance. Overall, with the exception of oil, commodities are a sell on rallies.
Currencies: The dollar gave back a lot of its gains versus Europe in 1998. I’m reasonably encouraged by its rally off 1.57 DEM. If support very close to current levels of 1.63 DEM can hold, the immediate prospects are bullish for an eventual break to new highs over 1.89 DEM. Sterling’s fate has been inextricably linked to the dollar for 3-4 years. I see however, a good chance for further slippage towards 2.65 DEM +/- 3 pfennig. This would be a superb long-term buy.
I’m not so sure UK entry into euro is as much a given as it was previously. If you disagree with me then against a spot GBP/DEM in the mid 2.60s, long date sterling forwards would look very attractive, being sub-best case expected EMU entry levels. If like me you believe that the UK may eventually go cold on EMU, then a renewed GBP bull run looks likely. Either way, 2.65 DEM is a buy.
Millennium: We talked about the 8bp cost built into three month money over millennium earlier this year, suggesting this cost would get worse. It’s now 50bps (implying a 1 1/2 per cent charge for one month money over 1/1/2000). Banks have been well prepared for euro. The impact on millennium on them and particularly on their corporate and second/third World clients is much less known/planned for. A serious liquidity squeeze both coming up to 1/1/2000 and afterwards if things go badly, is a major possibility. |
Aidan Clare is head of bond and derivatives sales at Ulster Bank Markets. The views expressed are his own personal opinions.
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| Article appeared in the January 1999 issue.
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