Dollar weakness and oil price strength meant continued nervousness for global markets in October. Despite a good start, markets spent much of the month in negative territory, before moving ahead later on as the price of crude fell back. Late oil price weakness came after the US government reported a bigger-than-expected increase in pre-winter crude stocks, while a surprise interest rate rise in China - the first in nine years - pointed to lower Chinese demand and added to downward pressure on oil prices.
Over the month, the MSCI World Index gained 1.2% in local currency terms. Overall gains were driven by continental Europe (+1.6%), the US (+1.5%) and the UK (+1.2%), while Japan lost 1.1%. The pattern appeared rather different in sterling terms, given that dollar lost ¢2 against the pound, ¢3 against the euro and ¢4 against the yen. All markets made sterling-adjusted gains, led by Europe (+3%), while the weakest sterling performance came from the US, with a gain of 0.3%.
The strongest sector performances came from IT (led by semiconductors), utilities and telecoms, while healthcare, materials and financials all underperformed, with the latter led lower by insurance sector weakness on the bid-rigging probe at the largest insurer in the US. Prior to its month-end weakness, crude reached new record levels in New York, hit by the latest in a series of supply side shocks. Expectations were that production in Norway, the world’s third largest exporter, would be stopped by a ship owners’ strike. This would reduce supply as demand from China is increasing. Chinese consumption may be higher than anticipated as the economy grew a fester than expected 9.1% in the third quarter. The International Energy Agency has forecast consumption in China, which last year surpassed Japan as the world's largest consumer of the fuel after the US, to rise 15% to 6.3m barrels a day this year.
Higher oil prices have prompted fears of higher inflation and slower growth. In Europe, the German government cut its 2005 growth forecast to 1.6% from 1.8% as oil price strength puts the export-led recovery under pressure, while business confidence fell to a four month low on signs of a slowdown in export orders and consumer spending. However, record oil prices are being partially offset by the euro’s rise against the dollar, which fell to an eight month low against the eurozone currency and a six month low against the Japanese yen on concerns of a US economic slowdown. Negative economic and dollar sentiment is being reflected in waning US consumer confidence, which fell for a third successive month, as well as the equity market, which touched a new low for the year.
Meanwhile in Japan, the equity market hit a five month low as the country experienced its biggest earthquake since 1995, resulting in the first derailment of a ‘shinkansen’ bullet train since the service began four decades ago. The quake was centred on a mountainous region 125 miles north of Tokyo and generated aftershocks strong enough to sway buildings in the capital. The market reacted predictably to the events, with insurers falling and construction companies gaining.
While valuations are supportive of global equities, markets have come under pressure from uncertainty surrounding the extent of oil price rises and the impact on global growth, the outcome of the US Presidential election and monetary policy on both sides of the Atlantic. Nonetheless, we do anticipate that markets will stage a rally into the end of the year once the outcome of the Presidential election is known. In the US, expectations are gravitating towards the belief that the Fed will act to raise rates before the end of the year, while in the UK, recent evidence of softening across a number of areas of the economy, including manufacturing, housing and domestic consumption, is leading some forecasters to suggest that rates may now have peaked.

Global equities made a poor start to the quarter - posting their worst monthly performance in 18 months in July - before regaining some ground amid easing oil prices in August. However, the rise in the oil price towards USD50 a barrel at the end of the quarter meant that the MSCI World Index lost more than 2% in pound terms over the period as a whole.
Being a net importer of oil, Japan was hit hard by the rising price of crude and was the weakest performing region, losing more than 7%. Concerns were compounded by declining exports, suggesting that slowing growth in the US and China is also having an impact. Rising oil prices also led the US lower, losing 2%. Despite an uninspiring domestic backdrop of weak business confidence and slowing growth, Continental Europe fared slightly better and lost only 1%, helped by encouraging corporate sector results. In contrast, the UK was the only market to gain ground over the quarter, returning almost 3% amid mounting expectations that the peak of the interest rate cycle may occur sooner than previously anticipated.
By sector, energy was the strongest performing area, advancing strongly as the oil price rose to above USD50 a barrel. The defensive utilities sector was also among the gainers, while the weakest areas included technology, consumer staples and consumer discretionary, which came under pressure amid mounting evidence of a slowdown in consumer spending.
Markets remain uncertain about the impact of oil price strength on the economic recovery, with a combination of rising prices and a consumer sector slowdown suggesting that interest rate cycles may be close to peaking. Within the environment of rising rates, market leadership continues to move away from cyclical areas towards more defensive growth-oriented areas, while markets remain attractive in valuation terms.

Markets lost ground during July, with the MSCI World Index returning -3% in local currency terms as all regions lost ground. The best relative performance came from the UK followed by continental Europe, while the US and Japan both lost 3% to 4%. With just a handful of sectors making gains in absolute terms, the strongest performance came from energy, helped by a rise of more than 20% in the oil price to over $41 a barrel, while the defensive area of utilities also fared relatively well. At the other end of the scale, the weakest performance came from technology, with all areas of the market ending sharply lower.
In the US, second quarter GDP growth fell short of expectations, although Federal Reserve Chairman Alan Greenspan continued to talk up interest rates and the dollar, giving an upbeat assessment of the economy. Meanwhile, other Fed officials commented that they expect the recent consumer spending slowdown to be short lived. Greenspan suggested that further rate rises were likely, saying that he is prepared for a more dynamic adjustment of rates. Oil price strength was also a concern in Japan, leading to weakness in major exporters as investors anticipated lower profitability on concerns of falling consumer spending and slowing global growth. There was also some weakness in domestic demand related areas after an unexpected decline in service sector activity. Meanwhile in the UK, mounting consumer debt added to expectations that the August meeting of the Bank of England's Monetary Policy Committee would see another rate rise. Although rates were left unchanged at the July meeting, consensus expectations are for another quarter point rise as economic expansion beat expectations, retail sales remain strong, inflation is picking up and wage growth stands at a two-year high.
The current economic environment should remain supportive of equity markets as we progress through the second half of the year, although markets currently appear range-bound amid uncertainty over the extent of monetary tightening and the impact of prevailing oil price strength. Further out, the contribution to growth from the robust government spending of the last couple of years will ease in 2005, following the US Presidential election and the UK general election. Against this backdrop of rising interest rates and easing economic growth, market leadership is expected to continue to move away from cyclical areas towards more defensive growth-oriented areas.

Global markets were little changed over the quarter, as a positive start amid growing optimism over the strength and sustainability of the economic recovery gave way to concerns over increasing inflation and worries that the Federal Reserve would have to raise interest rates earlier and by more than had previously been expected. Markets were also rattled by ongoing hostilities in the Middle East and the resultant oil price strength.
In the US, economic and corporate news has remained positive, with GDP growth of 5% being reported for the first quarter of the year as household consumption has remained strong and capital expenditure has shown an improvement. Employment - the missing piece in the economic growth jigsaw thus far - also finally showed an improvement, suggesting that companies have started to hire staff, in addition to keeping their focus on improving productivity.
Meanwhile in Japan, first quarter economic growth came in ahead of expectations as lower unemployment boosted consumer spending, with hiring by manufacturers pushing the jobless total to a three-year low in March.
The UK economic backdrop was one of continued stability, with GDP growth exceeding the market's expectations and little obvious evidence of inflationary pressure. Amid an improving global economic picture, growing concern at the build-up of consumer debt and the ongoing strength of the housing market, the Bank of England raised rates by a quarter of a percentage point on two occasions during the quarter.
In contrast, Continental Europe has continued to lag its global counterparts, with unemployment remaining high and domestic demand weak. Consequently, the region is forecast to grow at just 1,7% this year.
Going forward, the fund manager's expect the economic environment to continue to be supportive of equity markets through the remainder of the year.

With holdings in almost 600 companies, Old Mutual Global (OMG) is not for those seeking nimble-footed, focused share selection. But what OMG does offer is a consistent record of returns exceeding its benchmark: 93% of the MSCI world index and 7% based on call-rate yields. Fund manager David Ross is upbeat on prospects for equity but he leans towards defensive stocks. This is reflected in OMG's top-10 holdings that comprise 15% of total equity exposure.

Having paused for breath in March amid concerns over the heightened security threat, global equities resumed their uptrend of earlier in the year in April, with the MSCI World Index advancing a further 2% to trade close to its 23-month high. All regions moved into positive territory, with the UK and Europe the strongest in local currency terms - both making gains of over 4%. With a welcome absence of any high profile terrorist activity by way of a distraction, investors were able instead to focus on corporate and economic newsflow, which remained broadly positive.

In the US, a number of household names such as Microsoft and Motorola reported profit ahead of expectations and were subject to earnings upgrades, while economic news also gave grounds for optimism. Stronger durable goods orders increased the likelihood that the Federal Reserve will raise its target interest rate before the presidential election in November. First quarter economic growth forecasts suggest that fourth quarter GDP growth of 4.1% will be exceeded, while consumer confidence rose to a three month high amid optimism over job creation.

Meanwhile, expectations that faster economic growth in the US would benefit exporters in Japan enabled the market there to continue its upward progress. Since the start of the year, the MSCI Japan Index has beaten the World Index by 10%, with a number of blue chips benefiting from improved earnings guidance. Heading west, the Ifo survey of German business confidence unexpectedly rose in April for the first time in three months, reinforcing the European Central Bank’s view that interest rates do not need to be cut as the current level is supportive of the euro and prompting speculation that the ECB would reject calls from some bank officials to cut rates. UK rates were also left unchanged at the monthly meeting of the Bank of England’s Monetary Policy Committee. The Bank subsequently cited stronger sterling and weaker manufacturing output as the basis for its decision. Majority opinion now points to another quarter point rise at the May meeting.

Expectations of strong global growth over the course of this year provide grounds for optimism that equity markets can enjoy further upside, while the benign inflationary outlook is expected to be positive for the global interest rate scenario. Given that 2004 is an election year in the US, the authorities will want to ensure a continuation of the favourable fiscal and monetary environment in order to maintain steady growth. Whereas European growth is expected to be below that of the US, Asia is likely to continue to make strong headway, with the rapid economic expansion being enjoyed by China set to have a positive impact throughout the region.

Global equity markets enjoyed a strong year-end rally, buoyed by news of the capture of Saddam Hussein and further evidence of a mounting economic recovery. During December the World index gained almost 4.5% in GBP terms, giving a gain of 10.5% over the fourth quarter. The best performances came from the US and Europe ex UK, both with gains of around 12%, although the picture was rather different in common currency terms, as the dollar lost almost 6% against a basket of international currencies over the quarter. The dollar's weakness was particularly pronounced relative to the euro, meaning that in euro terms the European market was almost twice as strong as the US.

Concerned over escalating consumer spending, the Bank of England became the first of the world's four major central banks to raise interest rates since 2000, increasing its benchmark lending rate by a quarter percentage point in a reversal of the July cut. In contrast, the European Central Bank maintained its benchmark lending rate at 2% amid the slowest European growth rate in a decade. In the US, a positive third quarter reporting season and encouraging economic data releases gave grounds for optimism, with retail sales, industrial production, consumer confidence and producer prices all improving, pointing to a strengthening economic recovery.

Looking ahead, expectations are for economic growth to continue to improve, heralding stronger corporate earnings. This should help to underpin equities in the near term, although further out the spectre of higher interest rates may weigh on markets. Continued dollar weakness is also expected to be a key theme at the forefront of investors' minds as we move through 2004.