As what passes for summer in Ireland moves along, news from stock markets stays changeable. In recent weeks, share prices throughout the world have regained their upward trends led by signs that the Japanese authorities are beginning to take more decisive action to revive their flagging economy.
The key elements of the Japanese plan would seem to be permanent income-tax cuts and the establishment of a Bridge Bank to take over the banking system's bad loans.
The Japanese yen has stabilised on this news, but sentiment towards Asia remains fragile. US and European stock markets have improved due to the more hopeful news from Asia. However, gains in share prices have been tentative and, increasingly, financial commentators are pointing to signs that economic growth could slow down significantly in coming months.
In fact, in Britain, the manufacturing sector has begun to contract and there are real fears that high interest rates and the strong sterling exchange rate may tip the economy into recession later this year.
Continental European economies grew quite strongly in the first quarter of this year, but recent data point to a slight slowdown in the second quarter. In the US, the economic expansion has remained strong until now, but exports have been slowing sharply.
Not surprisingly against this backdrop analysts have been scaling back their expectations regarding corporate profits. Company profits in the British market are now forecast to show virtually no change this year. Private investors who have seen such strong gains in their equity portfolios in recent years must now be wondering whether they should redirect their investments out of equities.
The big problem is to find attractive alternative investment opportunities. The table shows 10-year government bond yields and one-month money-market interest rates for a number of markets.
Persistently, low inflation and signs of economic slowdown have resulted in historically low bond yields throughout the world. A gross yield of 5 per cent in a 10-year Irish Government bond is only attractive in the context of a recession. With the economy growing strongly and inflation rising towards 3 per cent, investing in Irish bonds seems singularly unattractive.
Irish deposit rates are somewhat more appealing at just over 6 per cent even if these are historically low interest rates. However, as we get closer to D-Day for monetary union, Irish money-market rates will have to decline to the interest rate prevailing for the new currency.
Estimates for euro interest rates vary from around 4.5 per cent, which represents the average rate of the 11 founding members, to the current German rate of 3.5 per cent. Recently, market sentiment has shifted to a view that interest rates will converge on the German rate because of the need to nurture economic recovery in Germany and France.
Whatever the eventual outcome it is quite clear that Irish money-market rates will be 1.5-2.5 percentage points lower than they are now by the end of this year. After-tax returns on even large deposits are likely to be below 3 per cent. Such low returns from bonds and cash are unlikely to tempt many investors away from the equity market except in the case of an outright bear market.
Although stock markets are likely to continue to fret about Asia together with a more general slowdown in corporate profits, the risk of an outright bear market seems very low. Europe and the US are in rude financial health and seem well equipped to cope with the negative reverberations from Asia. Low inflation and low bond yields underpin this stable economic environment and should act to sustain equity markets.
With interest rates going to rock bottom levels and property values on high ground the long-term argument in favour of equity investment will continue to hold sway. As has been the case so often in the past, staying with the equity market through this somewhat bumpy period will probably pay handsome dividends over the long haul.
