Equity outlook remains positive

Equity markets have wobbled after their rise to record highs. In the US, the S&P 500 fell by 3% in early June, while Germany's DAX tumbled by 4.6%. Is this just an inevitable but temporary correction, or the start of a more serious sell-off?

David Kiddie, ABN AMRO Asset Management's new Global CIO Equities, believes the dip in equity markets is not the start of a meltdown. After a period of good performance, it is natural to see a shake-out. "I don't think this is more than a correction", he says.

With many markets close to record highs, he believes that market participants were looking for an excuse to take profits. "Earlier this year, developments in China and in the US sub-prime mortgage ma"ket were used as an excuse to sell equities," he says.

A similar shake-out has now occurred in the bond market. The yield on the ten-year US Treasury has now risen above 5% for the first time since August 2006, as expectations of US rate cuts have evaporated amid signs of stronger economic momentum. In Europe, the ECB raised rates to 4.0% in early June and comments by the bank's president, Jean-Claude Trichet, that monetary policy is still on the accommodative side suggested that more hikes are on the way. At 4.60%, the ten-year Bund yield is at its highest level since 2002.

Even so, Kiddie remains optimistic about the outlook for equities over the next one-to-five years. He sees a handful of factors that should support the asset class.

First, inflation pressures and interest rates are low. "Although interest rates in major markets have risen, they are still low historically and support high equity valuations," he says.

Second, corporate profit growth is decent, also supporting raised equity levels. Third, equity withdrawal, in the form of private equity bids or other M&A activity, is continuing. "In the UK and Europe, corporate activity is relentless. The proceeds of deals are reinvested in the market, pushing it higher still," Kiddie says.

Fourth, he believes that equities will be shored up by continued global economic growth. He highlights the momentum of development in the major industrialising countries around the world, such as India and China, and he is not overly worried about a bubble in China. "The Chinese market is going through a gradual process of development. Markets can rise by 7-8% in a day. China is a market in which to invest money and not worry about day-to-day movements. You should leave it for ten years," he says.

In particular, Kiddie is optimistic about equities in emerging markets and Asia Pacific. "While valuations are creeping up in developed markets, the fundamentals in these areas are good: lower risk profiles, lower country defaults in Russia and Turkey among others, higher earnings growth and continued outsourcing growth," he argues.

What could endanger this upbeat scenario? Kiddie points out that increased inflation, higher bond yields, a slowdown in the US as the consumer finally cracks, or lower corporate profits would all be a concern.

On the size and style front, Kiddie believes the picture is mixed at the moment. "Large caps should be doing better, as the economic cycle is in its later stages. But there has been so much equity withdrawal that it is underpinning the small- and mid-cap sector," he points out.

Similarly, he's agnostic about style. "Some traditional value stocks have recovered well, some growth stocks are at reasonable valuations. There is still a demand for yield, so a high-income approach should continue to reward investors. There is no compelling case for either value or growth at the moment," he concludes.