A wide range of factors have influenced equity markets in 2003. In the early months, there was a c...
A wide range of factors have influenced equity markets in 2003. In the early months, there was a continuing hangover from extreme risk aversion on the part of investors and the relationship between equity earnings yields and bond yields became extreme.
This was also the period of the build-up to the Iraq conflict, which gave investors cause to sit on the sidelines.
Despite massive fiscal and monetary stimulus in the US, there were no particularly strong signs that industrial production or corporate spending was about to take off so confidence in earnings forecasts was low despite the fact revisions were beginning to turn positive.
The post-Iraq rally was sharp but lacked conviction and by the end of June, the S&P was only some 10% higher than it was at the end of March when hostilities commenced.
Although there were expectations of an even stronger rally, the market was held back by the fact valuations in the US were still demanding in a longer-term historical context. In addition, bond markets had started to weaken by the end of June, removing support from certain large cap areas of the market.
Against this general background, there has been a dramatic positive shift in the performance of mid and small- cap stocks. Corporate activity has picked up, with banks happy to lend to venture capitalists to pick up value situations with good free cashflow.
In addition, the bottoming out of the capital spending downturn has led to a dramatic recovery in technology stocks, many of which had been languishing at valuations not seen since the last downturn in 1990-1991. Given the continuing policy of central banks to provide easy money to markets and the strength of banks' balance sheets, we see the momentum in corporate activity continuing, providing support for potential bid targets and companies looking to re-finance.
The bond market outlook is stable in the short term after the recent sell-off, which should enable the more blue-chip areas of the equity market to improve.
Ultimately, equities need to see evidence of a general and sustained pick up in economic growth to create expectations of earnings revisions into 2004 and 2005.
Our favoured regions on a one-to-two-year timescale are the Asian and emerging markets, followed by the UK and Japan.
We see Asia as the best potential beneficiary of an economic upturn and least likely to be held back by any bond market weakness.
The US market will benefit from earning upgrades but valuations are not as attractive as elsewhere and there is still a risk of consumer retrenchment into 2004 as the housing related borrowing boom subsides. Japan remains difficult to predict but recent economic data has been better than expected.
The make-up of the equity market is also more geared towards manufacturing than many other markets, so again investors will benefit from any global growth trend.
It seems likely the coming 12 months will see more of the same; a gradual improvement in profitability, earnings upgrades and rising equity markets.
US market will benefit from earning upgrades
Corporate activity has picked up.
Recovery in technology stocks.
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