Global political and economic events last month were overshadowed by the terrorist attacks on New Yo...
Global political and economic events last month were overshadowed by the terrorist attacks on New York and Washington on 11 September. Equity markets, which had already been trailing lower on disappointing economic and corporate news, plunged to levels unseen since the 1998 LTCM crisis. Bonds and traditionally safe haven currencies such as the Swiss franc were the biggest beneficiaries.
Although the probability of a severe recession in the US has increased because of the risk that consumption will falter, we do not believe it is as inevitable as markets are currently discounting. Spending will almost certainly fall over the next two months, but it would take a sharp rise in the unemployment rate or a steep decline in housing prices (translating into lower real incomes and spending) to cause economic activity to contract throughout the first half of 2002.
While it is true that some companies are aggressively trying to cut costs by reducing their headcount, the losses have so far been moderate, and the housing market, which is the single most influential contributor to consumer wealth, remains relatively robust despite pockets of weakness.
Furthermore, a combination of even lower interest rates and higher government expenditure (compensating stricken industries and rebuilding affected areas) should stimulate growth as 2002 progresses. Although UK growth is also expected to slow during the remainder of the year and in early 2002, it should remain relatively healthy.
Much depends on the US response to the attacks and financial markets are likely to remain volatile for the next two or three months until a clearer picture emerges. However, there have been several occasions in the last twenty years and most recently in 1998 when markets have faced crises of some sort or another that could have led to disaster. None did and they are now regarded as good opportunities to have bought equities. These are cheaper today in the US, Europe and the UK than they were in 1998 (relative to bonds), indicating that the level of pessimism is extremely high.
Looking beyond the next three months, this is presenting huge opportunities at current relative sector levels: for each sector that has risen strongly since the attacks (traditional defensives like utilities and pharmaceuticals); there is another that has suffered larger falls (travel and particularly airlines or entertainment and leisure).
As and when investors shift their focus from the short- and medium-term implications for economic growth and corporate earnings to the stimulatory effects of abundant liquidity and industry restructuring, many defensive sectors, which had already vastly outperformed the market prior to the attacks, will start to lag.
Instead, sectors recovering from historically low valuations and market underperformance will be back in vogue. It may not be the right time to buy just yet, but ideas for prospective portfolio moves are forming.
Equities are cheap relative to bonds.
Opportunities at relative sector levels.
Further monetary easing expected.
Short-term markey volatility likely.
Investor pessimism is extremely high.
Risk of severe recession in US.
Richard Prew is manager of the Henderson UK Capital Growth Fund
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