Early in 2000 the current expansion will become the longest in US history. Earnings have enjoyed pro...
Early in 2000 the current expansion will become the longest in US history. Earnings have enjoyed prolonged growth, the budget is in surplus for the first time in 30 years and interest rates and inflation have enjoyed a downward trend despite unemployment being barely over 4%.
As for the equity market the S&P 500 has provided a spectacular return of 17.6% pa in the 1990s and is up over 24% pa and 27% pa respectively over the last three and five years. The market has tripled since late 1994, a time when many asset allocators viewed it as expensive.
So what can the US market do for an encore in 2000? A repeat of the recent exceptional returns seems unlikely but many of the positive fundamentals remain in place and would argue against an overly pessimistic view of Wall Street. Earnings growth of 10% in 2000 appears achievable aided by significant exposure to rebounding global economies. In addition, the supply/demand picture remains positive as money flows continue into equity funds and proposed changes in accounting and financial regulations could encourage further brisk M&A activity.
The main concerns over the US market tend to centre around valuation issues and inflation/interest rate fears. Over recent years, many valuation yardsticks have proved untimely guides to the US market whilst inflation has continued to surprise on the downside despite domestic growth continuing to surprise on the upside.
With respect to valuation and inflation it is necessary to appreciate the increasingly important influence and impact of both the US technology sector and the dawn of the Internet era on the US market and global economy.
With respect to market valuation, technology now represents nearly 30% of the S&P 500, up from less than 10% just a few years ago. Companies such as Microsoft, Intel, Cisco Systems and Dell Computer are now amongst the largest US companies and have been enjoying dramatic growth and developing increasingly significant global franchises.
It seems natural therefore that with the increasing importance of these high growth technology companies the valuation of the market as a whole should expand by historic comparison. Layer on top of this the effect of 'new economy' internet-related companies such as America Online and Yahoo and the growth and valuation characteristics are exaggerated even further. In simple terms, the profile of the market constituents is changing, along with their growth prospects.
As for inflation, again technology and the internet have, and will, play an important and beneficial role. Increasing globalisation and competition have brought a constant demand to improve costs and efficiency. Consequently restructuring moves have led to an enormous secular demand surge for technology equipment as a way to improve productivity.
With labour costs representing two-thirds of US business costs, this trend of substituting capital for labour is an important driver in the explosive demand growth for technology. As for the internet, we are still in the early stages of its influence on prices. With the access to the internet becoming easier and cheaper its impact will continue to grow significantly.
The Web's deflationary influence is not only on the consumer but also the opportunity for business to business e-commerce is growing fast; this offers a projected market four times the size of consumer e-commerce. The bottom line is the internet is destined to save significant costs and thus maintain downward pressure on prices and inflation.
Although valuations may appear excessive by historic comparisons, the underlying fundamentals argue that it would be a brave person who continues to bet heavily against US equities.
Andrew Pringle is director of US equities at Friends Ivory & Sime
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