Susan Easton: Pundits dusting off rosy specs for 2011

Opinion

It's that time of year when the pundits are rolling out their forecasts for the year ahead in global sharemarkets.

It's a distinctly different tone compared to a year ago and there are plenty of rose-coloured spectacle-wearing analysts about.

Forecasts of 1450 for the S&P 500 abound (a 17 per cent advance from mid-December) and depending on the particular market the numbers seem to be settling mostly in a range of 10-20 per cent, with a definite tilt to the upper end.

The bears still have their claws out, but those prepared to commit pen to paper and call for negative returns in 2011 seem to have gone into hibernation.

In US dollar terms, developed country share markets are up 8.5 per cent for 2010, with emerging markets up 14 per cent. So what's the chance of 2011 being an even better year?

The global economy is showing signs of improvement. With corporates continuing to report solid earnings and a number of central banks hell bent on preventing deflation, those rosy forecasts for share markets might not be as pie-in-the-sky as they first seem.

We've managed to skirt around the European sovereign debt crisis even though some of those countries are still teetering on the edge. Deleveraging governments' balance sheets will take time and require some painful reductions in government spending.

The hope remains that, with enough time, economic recovery will improve the fiscal situation and that European banks will have got their balance sheets in order to the point where they can accommodate debt haircuts. Even if Europe continues to flounder, maybe the rest of the world can soldier on regardless.

The US appears to be growing its way out of trouble at least judging by some of the main indicators such as industrial production and retail sales. Unemployment levels are proving somewhat stickier. This month's proposed extension to the tax cuts will be a further leg up for growth and corporate bottom lines.

China is moving ahead like a freight train and has the opposite problem to the West - they need to apply the economic brakes rather than speed things along.

The hope there is that the authorities will be able to dampen inflation without collapsing asset prices and economic growth in the process.

A recovery of sorts is definitely under way and that's reflected in forecasts for global growth. Consensus estimates are now edging above 4 per cent for 2011 with a spill-over effect to company earnings.

Having cut costs substantially during 2008, a large number of companies are now beginning to achieve more sustainable growth in profits on the back of increased volumes and/or higher prices and productivity improvements.

As a result, 10 per cent-plus earnings growth is being forecast for 2011, and corporate earnings yields of 7-8 per cent look significantly more attractive than real bond yields of 1-2 per cent.

Sharemarkets have responded positively to the improving economic outlook and it's quite likely the recent rise in global interest rates reflects higher growth (and inflation) expectations. The nominal yield on the US 10-year government bond has risen from a low of 2.4 per cent to 3.45 per cent in the space of two months. That's a pattern repeated to varying degrees in Japan, Germany and the UK.

However, what's good for the equity market is not necessarily good for bonds. That movement in the US 10-year has translated into an 8.5 per cent loss on the capital value of that particular bond - ouch.

Investors who've been stampeding into bond funds in the past couple of years will be feeling the pinch. And stampede they have.

According to Credit Suisse, since the beginning of 2009, inflows into global bond funds have been far stronger than inflows into equity funds. They estimate 95 per cent of new money has flowed into bond funds during this period.

In the past month there's some evidence of a turnaround in this trend - positive funds flow into equities and a stall of flows into bond funds. Another couple of months with reasonable returns from shares and negative returns in bonds and the dribble into equities might turn into a gush.

That would provide additional support for share markets and may justify forecasts of a 10-20 per cent advance in markets over 2011.

* Susan Easton is a senior equity analyst at Gareth Morgan Investments