The outlook for stock markets remains positive

WITH many predictions already made for market in 1996, readers may think an easy way to make money is to invest in the number one recommendation of the "experts". Consensus choices on markets are hardly ever correct, however, because by the time they become everyone's recommendation the best of the gains have already been made.

EUROPE: As a whole it is not a homogeneous block. There was vast disparity in stockmarket performance of the component countries in 1995. Investors might do well to concentrate on one or two specific markets.

A smaller market for investors to consider in 1996 is Spain. Spain has performed poorly in a European context over the last ten years, struggling with high inflation. A general election was held yesterday. If the conservative Partido Popular, as expected, takes control it plans to put in place reforms to reduce the budget deficit and allow interest rates to fall.

Moderate wage increases mean the outlook for inflation is good and this should result in falling bond yields. Traditionally the Spanish equity market has closely followed the direction of the bond market.

Thus, with the equity market currently very cheap relative to bonds and double digit earnings growth forecast, there is the prospect of a market re rating post the election. The Spanish stock market looks one of the most interesting in Europe at present.

PACIFIC REGION: Outside the OECD area, the world economy continues to be buoyant. This is especially true in Asia where the region, excluding Hong Kong, is likely to show growth of over 7 per cent. Markets in the region have got off to a good start in 1996 and it now appears that two years of under performance have come to an end.

Positive factors for 1996 include the continuation of robust economic growth and company earnings, combined with valuation levels which are now highly attractive. Last year saw fears of economic overheating in these markets.

Part of this was caused by flooding which temporarily raised food prices; countries within the region have also taken measures to cool their economies by raising interest rates. Thus, the fundamental economic picture for the region is much improved.

Within Hong Kong, economic growth continues to decelerate. This is actually a positive, as it frees up liquidity or cash, which is available to boost the stock market. Hong Kong will be a particular beneficiary from any further fall in US interest rates.

Thailand saw its current account and inflationary record deteriorate in 1995. However, much of the rise in the CPI was the consequence of summer flooding. Pre emptive measures last year to cool the economy, gives scope for interest rates to fall in the 2nd half of this year. With company profits set to grow both this year and next, the Thai market has significant upside.

A little known market in the region is Indonesia and this could be the "dark horse" of 1996. Although problems with the current account are set to remain, inflationary pressures will moderate further.

Administrative measures such as credit controls, will be used to reduce domestic demand, rather than higher interest rates. High economic growth continues to attract foreign investment. With earnings growth of 20 per cent to 25 per cent forecast over the next couple of years, the market, on a prospective PE ratio of only 14, seems exceptionally cheap.

JAPAN: This year should see a significant improvement in the fortunes of the real economy in Japan. The authorities there have at long last come to their senses and realised the seriousness of the situation. This led to a significant monetary and fiscal stimulus in the second half of last year.

In anticipation of economic recovery, there has been a surge of foreign buying. However, domestic institutions have been far more cautious and during 1995 they used overseas interest to off load shareholdings.

The biggest threat to the Japanese market is the fundamental weakness of the country's leading financial institutions. This leaves them always likely to sell shares in any market rally, in order to write off bad debts incurred elsewhere.

The Japanese stock market is notoriously difficult to call and shares trade on what, to western investors, are astronomical PE ratios. In some ways this makes values difficult to establish. One thing seems certain, huge gains are unlikely without a significant weakening of the yen.

This means non Japanese investors need to "hedge" their exposure to the yen. Otherwise, a good part of the stockmarket's rise may be wiped out by currency losses.

To conclude, the outlook for markets is positive at present, partly because consensus expectations on growth are too high. Interest rates have scope to fall further than people expect and remain at these low levels for a prolonged period of time.

Stock markets are interest rate driven and this allows the possibility of pleasant surprises in 1996, especially in Europe and the Pacific Rim.