Year 2003 in review and outlook for 2004 [Archives:2004/700/Business & Economy]

January 5 2004

Written by: Ebrahim Al-Hashidi
Yemen Times Taiz – Bureau

Throughout 2003, the global economy improved despite significant geopolitical uncertainty and the war in Iraq. Among the major industrialized countries, the United States once again displayed its great capacity to rebound rapidly, while consumers kept economic activity afloat in America for a long time, business leaders have become more optimistic and have started to invest again.
Thus US growth has been under printed by nearly all of its component parts since the summer. In Europe, the situation improved at a slower pace as Germany and Italy dragged economic activity downward at the beginning of the year. Since then, the renewed vigor of foreign trade has allowed the German economy to pick up and thus the economic situation has gradually improved in Continental Europe, albeit to a laser degree than in the United States. Japanese growth benefited from a satisfactory upturn in exports due to the major upswing in other Asian countries, notably China.
This permitted the “land of the Rising Sun” to put out from the doldrums. In addition to this external boost, domestic demand gathered steam during the year, and while 2003 will certainly not be a bumper year. It will have made it possible for global growth to shift into a higher gear.

Equities: confidence is back
In reflection of improving circumstances, stock markets started to move upwards.
In October 2002 markets entered a consolidation phase with a persistently high level of volatility after which investors regained their appetite for risk and the markets enjoyed a dramatic recovery. Several factors supported stock market prices and rekindled investor confidence.
First, liquidity was abundant after several years of simulative monetary policies. Second, company earnings improved as a result of restructuring and cost cutting. And finally, equity valuations regained attractive levels.
Cyclical sectors perform best in this environment. Barring any exceptional events during the last few days of the year, major stock markets should post positive performances in 2003, a first since the bursting of the speculative bubble in high-tech stock March 2000.

Bonds: laughter and tears
In the first half of the year the sovereign risk bond market priced in a scenario of deflation which caused yields on the 10-year US Treasuries to move from 4% to nearly 3% a level not seen since the early 60s. Bond yields in other industrialized countries followed a similar trend. In mid-June, and almost overnight, bond investors changed their expectations as to economic developments.
The yield on 10-year US Treasuries jumped to 4.6% in a matter of a few weeks, since when it has oscillated between 4% and 4.5% as the market consolidated.

Currencies: US dollar falls from grace
Despite cyclical improvement, the US dollar has continued its slide, which began in early 2002. Against the Euro, it weakened from 1.04 in early 2003 to 1.08 in late May.
Subsequently it has fluctuated within a wide range between 1.10 and 1.19. The twin deficits, i.e. the current account and the budget have worried international investors as have statements made at the September G7 meeting in Dubai indicating the potential for further weakness in the dollar. This also weighed heavily on the US dollar's exchange rate. Finally, gold continued to strengthen, and at times drew close to USD 400 an ounce.
Also the prices of several primary metals as well as that of all remained firm throughout 2003. Primaries due to the combined effect of the economic recovery and the weakness of the US dollar.

Cyclical upturn in the first half
The improving global economic environment is expected to continue during 2004. The positive effects of accommodating monetary policies will further boost growth.
Furthermore, several Western nations have implemented tax cuts with the United States being the first to act in this regard as it voted in a major tax-cutting program commencing in 2003. Finally, 2004 is the year of the US presidential election, and historically the run-up to such an election is positive for growth.
Continental Europe on the other hand appears set to remain lagging behind the United States as its more rigid structures and reduced capability of introducing fiscal stimulus packages due to the Maastricht criteria will curtail the possibility of a recovery.
Nevertheless, European economies did bottom out in 2003. And growth should return Asia is expected to continue benefiting from this upswing thanks to an increase in exports. A major question mark hangs over 2004 however in 2003 the economic recovery was mostly financed through rate cuts by central banks and by more tax control over government expenditures.
The private sector will have to take over the relay in the second half of 2004 otherwise the upswing might be short-lived. For the time being consumption and private investments appear to be the driving forces.
Although it is still too early to know whether or not the current positive trend will endure beyond the summer of 2004.

Equities: still some upside potential
Major stock markets took set to continue doing well, although the significant rise experienced in 2003 will probably limit prospects for 2004. Earnings growth should become the main driving force behind prices as we have entered the second phase of the cyclical upturn when after liquidity; earnings sustain stock market prices.
2004 performances are expected to be close to the historical returns recorded on the major stock markets with most of the rise likely occurring during the first few months of the year.
Emerging markets will likely post better riggers than those of the industrialized countries, as they are more exposed to the cycle and will benefit to a greater extent from a catch-up phase.

Bonds: even slightly higher yields
After the initial rise in yields last summer, government bonds could continue their consolidation phase started in the fourth quarter of 2003.
The strengthening economy however, will likely lead central banks, and notably the Federal Reserve, to tighten the monetary screws during the second half of 2004, which the bond markets will anticipate well in advance. The target yield for the 10-year US Treasury could be around 5%.

Currencies: the dollar remains weak
The dollar should remain relatively weak, as external deficits will not encourage an appreciation in the US currency for the time being. In theory, the improved dynamics of the US economy should support the greenback and prevent it from deteriorating to the levels experienced in 2003 (around 1019 against the Euro), although continued volatility could drive it down temporarily.
In conclusion, and barring any unforeseen negative external events, 2003 looks promising for the financial markets.
We remain at your disposal should you wish any further information. We would like to thank you for the trust you continue to have in us, and we would like to wish you all of the very best for 2004.