Royal Bank of Canada investment analysts are cautious on the US and Canadian markets while remaining generally bullish on European stock markets -- especially European Monetary Union members -- for the third quarter.

As at June 30 the group's global investment analysts recommend a portfolio allocation strategy of 48 percent bonds, 44 percent equities and eight percent in cash.

The recommendations were made in the bank's International Investment Outlook publication, which The Royal Gazette will receive regularly though Royal Trust (Bermuda) Ltd., the bank's subsidiary on the Island.

The analysts recommend equities holdings of 41 percent in the US, 32 percent in Europe, 14 percent in the UK, nine percent in Japan, two percent in Canada, one percent in Asia excluding Japan, and one percent in Australia and New Zealand.

In a fixed-income portfolio the analysts recommend holdings of 42 percent in the US, 35 percent in Europe, ten percent each in the UK and Japan, and three percent in Canada.

They indicate doubts about the US equity market even though indicators point to an economy growing about four percent in 1998.

"This favourable backdrop is being greeted with suspicion,'' they state.

"...The market is increasingly driven by mergers and acquisitions, but companies are using their inflated stock prices rather than cash to fund their acquisitions. This could call several deals into question if a significant market correction occurred. We therefore remain cautious on the US market.'' In Europe the birth of the Euro, due to replace the region's individual currencies in 1999, could be positive for investors, the analysts state.

"Clearly, it is Europe's turn to shine,'' they write. "The question now is whether Europe will continue to prosper once the Euro replaces the region's individual currencies on January 1, 1999. There is little on the horizon to detract from the region's economic prosperity. So for now, the enthusiasm over Europe's strength appears justified, and should translate into healthy relative returns for investors.'' While stock markets advanced about 25 percent in the first half, rising interest rates and a stronger currency will not be as good for stocks in the second half 1998, the analysts predict. The combination of a loose fiscal policy and higher interest rates means the shift from bonds to stocks will continue.

"In building a European portfolio, it now makes sense to focus on promising sectors rather than countries,'' the analysts advise. "That's because the largest companies increasingly have significant cross-border links and some sectors have become regional rather than national.'' A prudent strategy will be to look at countries and sectors with high sales in Europe, and to be cautious about those with high exposure to world trade or the US dollar. Royal Bank analysts favour Italy as one top pick.

"Earnings growth could be as high as 25 percent this year, and 16 percent next year, and return on investment is expanding faster than in any other European country,'' they state. "Despite these advantages, Italian stocks trade at a relatively cheap 8.9 times estimated 1999 earnings, a 25 percent discount to the European average.'' The analysts prefer banks, industrials, construction, and discretionary consumer goods over international stocks.

European Monetary Union (EMU) member economies could still face growing pains.

Potential problems may not become apparent for a few years.

"But at least until then, Europe's future looks bright,'' the analysts state.

"And if the transition to a single-currency market is well managed, it may well remain that way.'' Among non-EMU members the UK's outlook is predicted to become more attractive to investors. Latin America stocks, which the analysts recommend investors stay away from, will continue to suffer due to current-account deficits that continue to rise in Argentina, Chile, and Mexico.

"Many investors are waiting for a correction in the US market before returning, hoping to acquire cheaper Latin American stocks,'' they state.

"High real interest rates are hurting the region's stock markets.'' Mexico, meanwhile, could turn out to be a "pleasant surprise'' due to a buoyant economy and low unemployment.

Asian economies, which are in crisis, have reduced export, production and economic activity. A recession in Japan, Hong Kong, Thailand and some other countries is a possibility. The analysts predict real confidence might not return to the Japanese market until second quarter 1999.

The Royal Bank of Canada has won the Financial Times "Best Offshore Bank'' award. The bank's Bermuda subsidiary was set up as an exempt company four years ago.

Chart by Royal Bank of Canada UPS AND DOWNS -- Chart shows the perspective of several nations' ranking in relation to the business cycle. The chart was developed by evaluating country risk (political and economic), market liquidity and fundamental investment worthiness.

BANKER -- Bill Humphreys is managing director of the Royal Trust (Bermuda) Ltd., an offshore subsidiary of the Royal Bank of Canada located at Corner House on Church Street.