Economy remains good for investors

Investor An insider's guide to the market After a decidedly mixed first quarter, equity markets around the globe have sprung…

Investor An insider's guide to the marketAfter a decidedly mixed first quarter, equity markets around the globe have sprung back into life during April.

The Irish equity market has fully participated in this rally and remains one of the top-performing equity markets so far this year. Further strength in the share price of Elan Corporation continued to boost the ISEQ Overall Index.

However, in April, the rally was quite broad-based, with the financials and CRH in particular enjoying significant share price gains.

Good news from US companies regarding first-quarter earnings reports was a key factor that underpinned the improvement in investor sentiment. Well over half of the companies in the Standard & Poor's 500 index have now reported first-quarter earnings and close to 80 per cent of these have surprised the market with better-than-expected earnings.

READ MORE

Profits at large American companies have been growing steadily over the past 12 months and the batch of reports currently being released have lead many analysts to further increase their estimates for 2004 full year earnings.

Confidence in the ability of the American corporate sector to maintain this strong earnings momentum is also being helped by mounting evidence that the US economy is now growing rapidly.

Strong growth in gross domestic product in the first quarter is likely to carry through into the second quarter and the current period may witness an even faster pace of growth than that recorded in the previous quarter.

Worries about the sustainability of the economic recovery in the US have now all but evaporated and this is undeniably positive for global equity markets.

However, it does mean that a rise in the US Federal Funds rate from the historical low of 1 per cent is now inevitable.

A sharp rise in rates would lead to a reversal in stock markets and could derail the economic recovery.

Statements from Federal Reserve chairman Mr Alan Greenspan and other Fed governors have made it crystal clear that any rise in interest rates will be gradual and modest.

Inflation has picked up a little but central bankers have welcomed the rise as it has all but removed fears of deflation. At the same time, inflation is unlikely to become a problem, as it seems set to remain in a 1-2 per cent range and, therefore, there is no immediate pressure on the Fed to raise interest rates.

Therefore, it seems that the inevitable rise in US short-term interest rates will be gradual and modest.

As long as corporate profits continue to grow in line with the robust economy, it is likely that investors in the equity market will not be unduly concerned by higher interest rates.

Turning the spotlight across the Atlantic reveals a somewhat more complicated picture.

The conventional wisdom is that Europe remains mired in a faltering and barely visible recovery.

However, this only tells part of the story, as there are several European economies, such as Britain, the Republic and Spain, that are enjoying satisfactory rates of economic growth.

It is really only the large core euro-zone economies of Germany, Italy and France that are finding it difficult to break out of a cycle of low growth, high unemployment and rising financial deficits. However, even in the slower growing European core, the economic news has been mixed rather than unremittingly poor. For example, the IFO survey of German business confidence for March, which was released earlier this week, was significantly stronger than expected.

This closely watched index is based on a survey of 7,000 companies and the March results are consistent with a moderate rate of economic expansion.

The Munich-based IFO said that the improvement in sentiment was linked to the recent decline in the euro/dollar exchange rate, which helped prospects for exports.

Therefore, the survey indicates that exports continue to be the main driver of Germany's gradual economic upturn.

As long as the euro stabilises around current levels, it is likely that the strong growth trend evident in the US will translate into further growth in German and European exports.

On balance a sustained but slow economic recovery still seems to be the most likely scenario for Europe over the next 12 months.

With the US and the Far East experiencing favourable economic conditions, global demand should continue to benefit European exporters.

If European growth seriously falters, the European Central Bank (ECB) has stated that it is ready to reduce euro interest rates in such circumstances.

Recent economic data support the view that the ECB will not need to lower rates and the current 2 per cent rate should be low enough to support the economic recovery.

For Irish investors, the unfolding global and domestic economic and financial environment continues to be a favourable one and should be sufficient to support a continued gradual uptrend in the global and domestic equity markets.