In 1998 only 25% of the stocks in the S&P 500 index managed to produce returns greater than those of...
In 1998 only 25% of the stocks in the S&P 500 index managed to produce returns greater than those of the index
The successful companies overwhelmingly shared two characteristics: size and growth. The top quintile of the index by capitalisation and by P/E ratio (as a proxy for growth) beat the S&P's own returns, the other 80% underperformed
This extraordinary position was more pronounced at the beginning of the year. Thankfully the situation has eased and by the second quarter a broad bounce in previously depressed areas saw 60% of stocks showing some relative strength
This broadening of interest coincides with a surge in earnings estimates as it was realised that economic growth, rather than fading in the wake of the Russian crisis, had continued at a busy pace. Consensus top down expectations for earnings are now for +12% for the year
This growth is predicated on the economy expanding by more than 3.5%, reflecting a continued consumer spending and increased manufacturing output. This latter component has risen for seven months now, reflecting an end to the destocking which recessionary fears produced, followed by a steady increase in demand as reserves are built against the Y2K threat
There has been for some time a common chorus that there are no inflationary pressures in the US. This is not quite correct both employment costs and commodity price increases will have an impact over the balance of this year and into next, enough to move the rate of inflation up to and perhaps through 3% in the first quarter
Resurgent growth in the US, rising activity in the rest of the world and an accelerating CPI will push cash rates higher. We have no view as to whether Y2K issues will prevent rates rising for a period around the year end, short term timing is not the issue, whether it is later this year or early next (or even both) we expect interest rates to increase by 50bps between now and the end of the first quarter and more later in the year
Expectations of higher interest costs will support the dollar for the time being, but as improved conditions elsewhere in the world economy impact on international fund flows, so the problems of financing a trade deficit equivalent to 4% of GDP should lead the currency lower
In terms of overall assessment we think that Wall Street offers more risk than reward at present. The biggest problem is the valuation levels against bonds which are very stretched. The correlation over time of equity yields and real bond yields is high, so when they move in opposite directions the position tends to be unsustainable
Our approach to investment is quantitatively based and we do not make significant sector bets, preferring to fund value across the market. Nevertheless 'value' is an important indicator and it is interesting just how strong a source of relative strength it has been since the end of the first quarter. We expect this to continue
John Kelly is investment director at BGI Funds
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