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Despite promising first quarter, outlook for equities cautious Add to ...

The best first quarter in more than a decade for global stocks would ordinarily be cause for rejoicing.

Not this time. Many analysts remain decidedly cautious about the outlook, pointing to continuing problems in Europe and slowing earnings growth in the United States, as well as the threat of a hard landing for China’s economy.

With the glaring exception of Canada, most major stock markets around the globe have surged in recent weeks, as fears eased that a debt default in Greece could trigger massive losses at banks in Europe and possibly knock down the global financial system.

In the United States, the S&P 500 index finished its best first quarter since 1998, while Germany’s DAX index also enjoyed its best first quarter since 1998 and the MSCI Emerging Markets Index completed its strongest quarter in 20 years.

But analysts say the banner quarter reflected some special factors.

The generally positive results from the Federal Reserve’s stress test of U.S. banks helped financial companies in the S&P 500 – the dogs of 2011 – soar more than 21 per cent from January to March, the biggest gain among the index’s 10 industry groups.

The index also received a major boost from Apple Inc. The tech giant reported a doubling of quarterly profit and a plan to start paying dividends, contributing to a 48-per-cent gain in its stock price.

Meanwhile, the European Central Bank flooded the market with liquidity through its Long Term Refinancing Operations, a move that ensured the continent’s banks would not run out of cash in the short term.

The question now is what can take stock prices higher.

While crude oil at more than $100 (U.S.) a barrel is good for earnings at oil producers, it increases energy expenses for companies and individuals and sucks away money from other investments. High U.S. unemployment and falling house prices are cutting into personal spending. The result is that corporate profits at U.S. companies are rising at the slowest pace in years, and some analysts forecast that they’re about to start shrinking.

The slowdown in China, the engine of global economic growth, further threatens to limit gains in earnings at corporations worldwide. The Shanghai composite index has risen only 2.9 per cent this year after three consecutive quarterly declines.

“A big slowdown in Chinese economic growth is the biggest risk we think markets face today,” Heather Brilliant, vice-president of global equity and credit research at Morningstar Inc., said in a note last week.

Investors are being cautious. “As the quarter progressed, investors – especially retail ones – opted to book gains that could easily vanish as the year progresses,” EPFR Global, which tracks money flows into and out of funds worldwide, said Friday.

Even so, Federal Reserve Chairman Ben Bernanke has so far held off announcing a new round of measures that so many are counting on to stimulate growth.

And while Europe may have averted a meltdown, it remains vulnerable. Stock markets there and in North America had their biggest drop of the year on March 6 after official statistics confirmed that the European economy contracted in the fourth quarter.

“In Europe, the picture has improved, albeit temporarily,” Ms. Brilliant said. “The European Central Bank has managed to avert a liquidity crisis, but … the underlying solvency problems are far from resolved.”

In Canada, stocks have been hit by disappointments at such bellwethers as Canadian Natural Resources Ltd., Kinross Gold Corp. and SNC-Lavalin Group Inc.

Of course, bull markets often climb a wall of worry and stock market bulls say the biggest reason for optimism is the generally cautious mood. If economic growth turns out to be stronger than expected, stocks could log additional gains.

“Despite the strong overall performance in the first quarter, there might still be some gas left in the tank for equities,” Robert Kavcic, an economist at BMO Nesbitt Burns Inc., said in a note to clients on Friday. “Recall that sentiment was very depressed in late 2011, providing a springboard for stocks in the first quarter. Sentiment has since normalized, but has yet to run bullishly amok.”

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