Full Report - Alliance Trust

11
sustainable. Although there are some encouraging signs that
this will occur in Asia, the picture is still far from clear in
Europe where unemployment remains high, both fiscal and
monetary policy are relatively tight, and the appreciation of the
Euro is threatening future export growth. The forthcoming
accession of Eastern European economies to the EU may help
stimulate demand within the region.
UK companies are also grappling with the impact of the falling
US Dollar, but UK domestic demand has remained relatively
robust, underpinned by the low level of unemployment and the
wealth effects associated with the recovery in equities and
ongoing strength in the housing market. Interest rates have
been raised already in the UK, ahead of the upward moves
expected around the world as the recovery progresses.
Companies
Conditions for many companies improved significantly during
our financial year. Increased demand, led by the US, produced a
recovery in profitability which helped to boost business
confidence. However, firms remained cautious on the whole,
achieving profits growth predominantly through cost cutting, using
cash flow gains to strengthen balance sheets and taking advantage
of cuts in interest rates to refinance debt at lower levels.
The recovery in profits and sentiment led eventually to an
increase in capital spending, particularly in technology related
products. Although layoffs have decreased, firms have been
reluctant, so far, to hire new workers, particularly in the
western economies where labour costs are high. One of the
main consequences of globalisation has been fierce competition
stemming from Asia, limiting pricing power around the world,
even as demand grows. Many western companies are still choosing
to relocate in Asia, particularly China, to exploit its lower labour
costs and thereby increase both competitiveness and profitability.
This trend could remain in place for some time, limiting
employment and income growth in the developed economies.
Equity Markets
The graph on the right illustrates the gains made in equity
markets during our financial year, on a Sterling adjusted basis.
This progress followed three consecutive years of declining
markets, one of the longest bear markets in history, which had
resulted in many stock market indices halving from their peak
levels. Since March 2003, markets have made good progress,
reflecting the easing of geopolitical concerns following the war
in Iraq and growing confidence in the economic recovery and
prospects for corporate profitability.
The US market performed best in local terms, rising 32% over
our financial year, but the depreciation of the US Dollar reduced
this to just 19% on a Sterling adjusted basis. The main equity
market indices rose 28% in both Europe and Japan and the
appreciation of the Euro and Yen boosted these gains even
further, to 33% and 31% respectively. The UK market rose 27%
over the year, held back by the more defensive nature of many
of its main companies.
At the sector level, technology stocks returned to favour,
boosted by evidence of a recovery in capital spending. The FT
World technology index rose more than 42% over the year,
retracing much of its decline of the previous 12 months.
Prospects of a cyclical recovery also enabled general industrial
stocks to perform well, rising more than 35% during our
financial year.
Investment Outlook
We expect economic growth to continue over the next few
months, as both fiscal and monetary policy will remain
relatively loose in the US ahead of the Presidential election in
November. Beyond that point it may prove necessary for other
regions to drive global activity forward, but this would require a
significant recovery in domestic demand in both Europe and
Japan. Both areas still have some structural problems to
address, particularly when currency appreciation threatens to
reduce competitiveness. In addition, the policy stimuli which
were necessary to generate economic recovery in the US have
caused imbalances there to worsen, leaving the US Dollar still
vulnerable to downward pressure. Further currency adjustments
may be required in the year ahead, but it is critical that these
moves are smooth as volatility would cause additional problems.
Equity valuations rose over the year in anticipation of a strong
recovery in company profits and this left some equities looking
relatively expensive by historical standards. Profits growth
should hopefully slow to a more sustainable pace over the next
few months. We would then expect stock markets to appreciate
steadily, if at a slower rate than we have seen recently.
Increased takeover activity may offer opportunities for
additional returns.
Equity Markets - Sterling Adjusted
31 January 2003 to 31 January 2004
135
130
125
120
115
110
105
100
95
Japan
Europe
Feb Mar Apr May June July Aug Sept Oct Nov Dec Jan
UK
US
Source: Thomson Financial Datastream