Wealth Planner:
Peak or Pause?

          Global equity markets today are more sensitive to the state of the US economy than in recent memory. Uncertainty about the direction of US monetary policy and the outlook for the US economy over the next year is making investors around the world exceedingly nervous. Three important questions deserve our attention:

  Are we at the peak of the current US interest rate cycle?

  Will the US economy slip into a recession in the next 12 months?

  Will US stocks rally?

          History shows that the US stock market tends to do well after the Federal Reserve ends a rate-tightening campaign, provided the economy does not fall into a recession. With several months of weaker-than-expected employment growth and signs of a slowdown in the housing sector, the Fed left rates unchanged at 5.25% on Aug 8, the first pause since June 2004. By looking at the rates for federal-funds futures, the market is pricing in a short-term interest rate cut next year, implying that the Fed may have overshot its mandate to keep inflation at bay.

          However, upon closer analysis, inflation pressures still remain. Overall headline-inflation increased by 0.3% in July, which translates into y-o-y inflation of 4.1%. Meanwhile, labour costs are edging up and energy prices still remain volatile, all of which will fan inflationary concerns. In summary, we are of the view that we are very close to the peak of this tightening cycle but not quite there yet. Since investors are not expecting this, as evidenced by the Fed-Fund futures rate, a rate hike could cause some market dislocation.

          Consequently, we continue to recommend an overweight position in our Global Allocation Fund vis-?-vis the SET especially now that the political risks in Thailand have increased substantially as a result of the September 19 th event.

Source: Bloomberg, S&P, SET and MSCI as of 15 August 2006