The market is expected to move sideways

The average price-earnings ratio of the S&P500 companies is presently 55.8x, up from 28.3x on September 21, 2001. Current sales and earnings trends are still weak, and might not be able to support the high market valuation. The implied 35% growth for each of the next five years appears unrealistic, as such high growth rate has never been achieved in past history.

Instead, investors might turn their focus to President Bush's USD90 billion federal budget proposal to the Congress on February 4th 2002. Strengthening of domestic security and reconstruction of the U.S. defense base are the two major additional items for 2002. Analysts have expected manufacturers of vaccines and bombs to be the major winners of the budget proposal. Bush's new budget is expected to call for tax cut for businesses and more unemployment benefit. He is likely to put pressure on the Congress to act on his energy proposal, with emphasis on domestic drilling, energy deregulation, and tax incentives for energy producers.

Shares of phone equipment manufacturers experienced a volatile week after analysts downgraded Nokia on concerns of weaker turnover for 2002. Nokia reported a better than expected results later in the week. Growing concerns about both earnings quality and momentum would hinder near term performance of the European bourses. Based on consensus estimates, current forward price-earning multiple of the European market is 18.4x. This implies that European equities are fully valued if earnings growth remains flat in 2002.

Germany has revised down its GDP forecast for 2002 from 1.25% to 0.75%. Economists are expecting more job cut and hence raising unemployment in 1H2002. The government is planning to speed up tax cuts if the opposition Christian Democratic Union manages to win the federal election in September. The tax cuts would temporarily increase Germany's deficit.

In Japan, the jobless rate is at its record high in almost half a century. It is expected to reach 6% in 2002 as companies continue to lay off workers to cope with slowing demand and weaker prices. The worsening economy is forcing Prime Minister Junichiro Koizumi to delay plans on cutting public works expenditure and to clean up bad loans in banks. These are steps that would initially increase the pain and could drive up spending on unemployment benefit. The Bank of Japan tried to combat deflation by keeping interest rates at close to zero, and pumping trillions of yen into the money market to force banks into lending. However, these measures are not really effective.