Uncertainty regarding the near-term prospects for the US economy and continued high levels of volatility in US stocks continue to be the key themes impacting on global equity markets.
The rally in the Nasdaq and the S&P500 engendered by the cumulative one percentage point cut in US interest rates, has proved to be short-lived. As the accompanying table indicates both indices are languishing significantly below their levels at the start of the year.
An early return to a trend of sustained rises in US equity prices still seems some way into the future. Indicators of business and consumer confidence continue to slip and forecasts of economic growth this year are averaging 2 per cent or less.
Recent data also point to a weakening in several sectors that had remained strong up to recently. A notable example is the previously strong housing market, where housing starts have suddenly slowed.
Speculation has mounted in the US that the Fed will act again in the near term by cutting interest rates further. The next FOMC meeting is scheduled for March, and a further cut in US rates by then has become a racing certainty. A pre-emptive strike by the Fed before the meeting seems unlikely and indeed could even backfire in terms of its impact on market sentiment. The unexpected initial half-point cut in US rates in early January served to reassure investors that the Fed was prepared to act decisively to engineer a soft landing for the economy. However, another surprise cut could have the opposite effect and may act to convince investors that the US economy is in worse shape than it actually is. This highlights the fact that monetary policy has very significant limitations in its ability to influence the direction of the economy, particularly over the short term.
So far the Irish economy and stock market have remained immune to the cold winds blowing across the Atlantic. Indeed the ISEQ index is one of the best performing markets globally and is up over 3 per cent so far this year. This makes it one of the best-performing European markets in 2001, with only Austria and Denmark doing better. A key factor in explaining the relatively strong Irish equity performance is the sectoral composition of the market. TMTs still only account for less than 10 per cent of the ISEQ by market capitalisation and hence the more defensive composition of the index has been a major support. In contrast, the technology-laden Nasdaq is down 7 per cent so far in 2001.
The key driver to the positive ISEQ return has in fact been the newer high-growth large industrials. In the pharmaceutical sector this includes Elan and Galen, while Ryanair in the airline sector has continued to outperform the global airline sector by a dramatic margin. The other sector that has acted to support the Irish market is the mid-capitalisation sector. Companies such as Grafton, Heiton and Kingspan have seen their shares enjoy a dramatic rerating in recent months. A key factor here would seem to be that the Irish institutions are no longer aggressively selling Irish stocks in order to rebalance their portfolios post the introduction of the euro.
At least for the first half of the year the Irish stock market does seem to have the capacity to continue to outperform. Performance beyond that will crucially depend on whether the economic slowdown in the US begins to have a negative impact on the Irish economy.
