Joe McGrath considers the outlook for global equities and measures the changing market sentiment for fixed-interest investment.

Equity investors will be more than happy with how their investments performed over the first quarter of the year, but talk of a double dip remains.

Looking at the regions, those who invested in southern Europe may have got singed, while those who ventured out to dabble in Japan were rewarded thanks to a surprising above-average performance.

That said, there remains plenty of positive sentiment on global equities from analysts and fund managers alike while fixed interest has lost some of the shine it had at this point last year.

While there is a general agreement that bonds are due to experience a natural lag, there remains a healthy portion of analysts warning of the risk of a significant correction over the next 18 months before we see a sustained bull market.

UK equities
For UK equities, all eyes are on where the next merger or acquisition is likely to spring from. The FTSE 100 has been awash with rumours of mergers in the financial space, particularly in the insurance and asset management sector – markets which have already witnessed a number of takeovers globally.

It would appear that the likes of Aviva, L&G and RSA (formerly Royal & Sun Alliance) are all fair game if market speculation is to be believed and investors in the City can smell blood right now due to attractive valuations and high free cash flows.

Currency trends have made British companies particularly attractive to overseas suitors, aided by the UK’s constructive takeover laws.

Clem Chambers, chief executive officer at ADVFN, is among the many renowned commentators predicting further merger activity over the summer – particularly in the insurance sector.

He explains, ‘The City has been talking to the insurers telling them they have got to consolidate. If you are one of the small guys, you are in play and they are all in the picture.

‘It is one big poker game. People are going to be coming and going. There is going to be one big Hells Angels’ takeover party. L&G and RSA will have to roll up and maybe Resolution to make a £10 billion company. L&G are looking like they are going to be snaffled up by someone and that is likely to happen this year.’

Away from insurance, there appears to be a buzz throughout the wider financial services sector. Recent news that J.P. Morgan’s results were much higher than expected, coupled with several ratings upgrades of UK banking groups, has brightened the outlook somewhat.

Bank of America/Merrill Lynch analysts have added further fizz to the party too, when they sent a market note last month saying that they expected Royal Bank of Scotland’s share price to double over the coming two years.

US equities
With the UK caught up in the build-up to the election over the past month and facing the prospect of a hung parliament, it was reassuring to hear a number of positive reports coming from across the pond.

US economists once again raised their expectations for the outlook for US gross domestic product growth as a result of increased corporate hiring and capital expenditures.

Most analysts are in agreement that the economy is still very much ‘in a transition’ stage but there is at least general agreement that the employment market rebound has started.

Bob Doll, chief equity strategist at BlackRock Investments, says that one of the risks to economic growth is about when the Federal Reserve will increase interest rates. He explains, ‘The central bank has maintained a cautious approach but we believe it will likely move away from its current emergency stance before too long and expect to see an increase in the Fed Funds target rate by the end of the year.’

Despite this, equity markets have, so far at least, posted decent returns this year, with strong corporate earnings and economic growth returning to the scene.

Doll says that he believes stocks will continue to ‘grind higher’ over the course of the year and corporate earnings will remain the main driver of equity prices.

Indicators of a US economic recovery are supported by the recent positive news on consumer spending. Government figures show that US retail sales rose 1.6 per cent in March, while US inflation statistics came in bang on target with a rise of 0.1 per cent for consumer prices. If the May US labour market statistics follow on a positive trend, a further boost to US consumers’ willingness to spend is also likely and a subsequent positive impact on equities will follow.

Asian equities
Fund managers investing in Asia have been falling over themselves to put out positive notes of sustainable and predictable earnings steams for companies over the coming months.

There is a general agreement that macroeconomic factors will play a less prominent role this year than the past year and that markets will be much more driven by sector-specific fundamentals.

According to a recent report from Standard & Poor’s, the Chinese market is widely expected to broaden out at the sector level although this expansion is likely to be dominated by the market leaders.

Agnes Deng at Barings is among those who have said earnings are likely to drive the market in 2010. She notes that this will be led by domestic consumption driven by the growth of the rising middle class. Louisa Lo at Schroders, meanwhile, is slightly less optimistic. She cut some of her more active positions in the fourth quarter of 2009 during a bout of profit taking.

ADVFN’s Clem Chambers is broadly in agreement. He says that a lot of Chinese companies are ‘incredibly over-rated’.

Invesco are among those that have been drumming up the positive story for India saying that infrastructure, consumption and outsourcing will be the key drivers of further growth over the second quarter of the year.
The investment house’s view has been influenced by the new government’s proposed divestment programme of
state-owned services and the country’s approach to contain the fiscal deficit.

Bonds
UK investors remain very cynical about the upbeat message peddled by Alistair Darling in this year’s Budget. Darling announced that the budget deficit for 2009/10 was going to be lower than previously forecast at £167 billion, suggesting that this could be more than halved by 2013/14.

The market was having none of it, however. Gilt insurance for 2010/11 is set to be more or less in line with expectations at £187.3 billion and the proportion of index-linked issuance will increase from 13 per cent to 20 per cent in a response to increased demand for these assets.

Outside of government bonds, corporate bond issuance continues to power through the uncertainty despite faltering during the beginning of the year after investors focused on budget deficits.

A number of high-profile stories emerged throughout April, including a £650 million sterling and euro bond
issuance from travel firm Thomas Cook Group.

Amanda Hernan, senior fund analyst at Fitzwilliam Asset Management, says that a positive earnings season, a growing belief that the recovery is on track and a search for yield appear to be the key factors behind the renewed strength in the credit markets.

Currencies
Despite being burdened by the Greek debt crisis, the euro has stabilised recently against the US dollar, triggering all manner of mixed messages from sector experts.

Investment group Julius Baer is in the camp which holds that a substantial recovery is unlikely at the current moment in time and that peripheral currencies are still preferable to the main currencies. The group notes, however, that the Swiss franc has little remaining upside potential against the euro.

It is fair to say that the tight fiscal position in the various countries will keep the international currency markets on their toes for some time to come but investor attention no longer remains exclusively on Greece. The euro has stabilised as a result, but analysts are still stressing that this is the biggest test that the currency has seen since its inception.