After another bad week on the stock markets, it is easy to get depressed. The main driver of global ...
After another bad week on the stock markets, it is easy to get depressed. The main driver of global growth, the US, is coming to a halt and this is striking fear in the hearts of investors. Japan is also causing concern, as the Government's paralysis of inaction threatens to plunge the economy further into the deflationary black hole. Technology mania has evaporated and some companies have lost 90% of their market value from their peak.
Global GDP will slow as the US economic growth grinds to a halt. But the Federal Reserve is taking a proactive stance by cutting interest rates, which will eventually provide the stimulus the market needs. The long-term growth of the stock market depends on the underlying profit growth of those firms in the index and so the present spate of profit warnings in the US is clearly worrying for investors. Corporate result statements are warning investors of a slowdown and a lack of visibility over future earnings as orders are cancelled or postponed. First quarter results are going to look bleak, but this slowdown should not come as a surprise after the feasting of the past few years. Investment banks have been spoilt because deals have been easy to come by, while analysts have been guilty of over-optimistic assumptions in their profit forecasts for tech-type stocks.
While Greenspan has failed to engineer a smooth glide back to trend GDP growth (an almost impossible task), he has remained proactive and bold in his policy decisions. We would expect the combination of tax cuts and looser monetary policy to start to turn the economy in the second half of the year and hope the market will start to look ahead, rather than focusing on the present.
Falls in rates are good for bond and equity markets and although the sharp falls in the US are unlikely to be repeated in the same magnitude in the UK and Euroland, it will provide central bankers with more flexibility in their policy decisions.
Low inflation and low interest rates means equity investors are still paying a premium for good quality growth stocks. But investors will have to be more discerning and will not be prepared to pay 60-80x earnings for a growth rate at twice the market. This adjustment is causing pain in the technology, media and telecoms sectors.
We still await the catalyst that is going to turn the market. But equity and bond yield ratios, earnings yields and falling interest rates are telling investors the market is cheap. The battle between earnings and interest rates may run for a few weeks yet, but stocks could turn sharply once sentiment improves. Institutional cash balances are large and fund managers will be under pressure to invest this money when markets rise.
There are now more reasons to buy than sell, and if you are buying, stock-specific funds should be favoured in the current environment.
Sam Liddle is director of LeggMason Investors' Managed Portfolio Services
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