The recent sharp fall in the US equity market pushed the peak to trough fall in the S&P Composite in...
The recent sharp fall in the US equity market pushed the peak to trough fall in the S&P Composite index over the 20% decline threshold that is usually regarded as the definition of a bear market.
For investors more focused on the Nasdaq, this may seem to be a moot point given its disastrous 62% decline in the last 12 months. The Nasdaq's record fall has seen some of the last year's hottest technology stocks fall 95% from their highs.
Despite the certainty of further monetary policy easing by the Fed, investors are focusing on the rapidly deteriorating outlook for corporate profits. Wall Street strategists' estimates for this year have declined from around 6% at the start of the year to around -2%. The most bearish estimates are closer to -15%, with technology sector earnings growth estimates now expected to contract by -30% this quarter. Cisco's chief executive, who commented that an industry upturn might not come until the fourth quarter, provided one of the numerous negative catalysts.
A big problem is that earnings visibility is non-existent and next year's profits growth estimates represent a shot in the dark. The hope that the slowdown will be V-shaped has receded and the more traditional U-shaped downturn appears more likely.
The economy is sending out mixed signals. The industrial and technology sectors are clearly in recession, but consumer spending patterns have proved to be more robust than expected. Housing and car sales are much closer to their peak levels than the trough levels seen in 19901991. Indeed, with two-thirds of consumption determined by the consumer, consumer confidence could prove to be the key. The Fed must ease the pain of stock market losses and signal to business that the consumer is highly sensitive to the severely depressed business conditions. It may then engineer a recovery in economic growth by the end of the year. We expect proposed tax cuts, falling mortgage rates and lower energy prices to help the consumer pocketbook further.
But a growing number of profit warnings from old economy companies has dented investors confidence. This is also likely to hurt capital spending, which has already been under pressure from the new economy's capital constraints, inventory excesses and profits contraction.
Overall, we believe the Fed will be forced to take substantial action on interest rates in order to shore up confidence. This view has been confirmed in recent weeks as evidence of weaker conditions in Europe and Japan will cause a further drag to global GDP growth this year.
We believe the preference for value will prove to be a theme for the rest of the year. Cyclical stocks are likely to be the biggest beneficiaries of the expected second half recovery. However, the tech sector is nearer the bottom now that the top 10 tech companies valuations match Walmart and Coca-Cola.
Terry Ewing is investment director at Britannic Asset Management
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