Rally looks set, but beware the hangover, says analyst
Strong upward momentum appears set to carry a year-end rally in global equity markets, despite the prospect of further increases in United States interest rates, dollar weakness and rising inflation.
Powered by an incumbent-president victory and easing oil prices, Wall Street in the past four weeks appears to be shelving much of the gloom that weighed on equities in the first three quarters, according to Timothy Hayes, global equity strategist for Florida-based Ned Davis Research Group. 'Technically it is in favourable shape right now,' he says. 'The market is focusing on the fact there is still enough positive momentum economically.'
Citing data going back more than 100 years, he says when an incumbent Republican president wins the White House, the stock market historically outperforms into the new year. A win by a Democratic incumbent tends to be neutral for the market.
'The markets don't like uncertainty,' he says. 'When the incumbent wins, you pretty much know the same policies are going to be intact.'
Friday's declines in New York, which saw major indices fall more than 1 per cent after Alan Greenspan expressed concern on the deteriorating US current account deficit, were accompanied by confirmation of long-established trends in the currency markets. The dollar fell to a 41/2-year low against the yen, while gold prices closed the week at US$447.05 an ounce, extending its 16-year high.
'Nothing has changed dramatically,' Mr Hayes says.
However, he worries the markets may face a hangover around February to March, a period that traditionally coincides with poor equity performance. Faced with a weak dollar, the Federal Reserve would have few options but to continue with its measured fiscal tightening. The outcome, he says, could be an economic slowdown at a time when markets are looking vulnerable after an extended rally.
'You could set things up for a more substantial decline than we saw this year,' he says. 'Sentiment is close to neutral, but if it continues to rally it would produce a lot of optimism which is unjustified.'
He said the weakening US dollar would lead eventually lead to imported inflation and could force the Fed to hike interest rates at a faster pace. 'I think there is still a window between now and next year, unless the dollar begins to decelerate faster than it is now,' he says.
He added pessimism towards the dollar was excessive, signalling a period of dollar strength may be near.
