After the valuation-induced bounce in markets at the tail end of 2001 and the Enron and accounting c...
After the valuation-induced bounce in markets at the tail end of 2001 and the Enron and accounting contagion of early 2002, markets are coming to terms with something rare ' good news.
It seems clear that the massive monetary stimulus provided by the US Federal Reserve is having the required effect in the US and is providing the economy with the necessary fuel for a full-bodied recovery.
This is being helped along by the recovery in inventories in the industrial sectors from the extreme lows of the fourth quarter.
That the markets have rallied so sharply recently is partly due to the fact that the positive information had been filtering into the market for a while but had been ignored during the period of Enronitis and accounting practice chest beating.
Thus, the shock that the Fed's medicine was finally working probably dragged some of the hedge fund bears to close some of their more exposed positions.
It is also likely that the bad debt and balance sheet scare stories that fuelled the bears recently will prove to have been a normal part of the economic cycle rather than an endemic problem likely to derail recovery.
There are reasons to think that a selective approach in these markets may prove fruitful.
It would be reasonable to expect the recovery in the economy to lead to a recovery in profits and it is just such a recovery in profits that the market is starting to discount. Selectivity is needed because the cyclical recovery is not equally discounted at present across the market.
Fund managers must be wary of the already heady valuations that can be seen in some cyclical stocks.
A focus on long term value with operational recovery not yet priced by the market should bring rewards. At the stock level, this would lead me to favour Valeo over BMW, for example.
Elsewhere, the pharmaceutical sector appears vulnerable to further bad news. Having reached relatively stretched valuations on the basis of its safe haven status in the period since the bursting of the technology, media and telecoms bubble there has been a wave of disappointments as the Federal Drug Administration in the US has rejected data or halted trials of a number of compounds.
Roche is my favoured stock at the moment in the sector. The merits of a robust balance sheet, little to worry about from patent expiry, valuation and the outside chance of corporate activity allow me to favour the stock in a sector I don't really like.
Sector rotation itself is likely to remain prevalent, with each rally and correction seen by many as a chance to switch.
It is clear sentiment is still fragile but I remain convinced that there is value out there if a selective approach is taken.
Economic recovery underway.
Earnings revisions turning more positive.
Valuation generally benign.
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