Recent data has revealed a slowdown in the pace of economic growth. As this slowdown unfolds, and co...
Recent data has revealed a slowdown in the pace of economic growth. As this slowdown unfolds, and core inflation remains well behaved, the likelihood that the US economy will achieve a soft-landing in the latter part of the year has grown. Interest rates were kept on hold at the last meeting of the FOMC and with a modest tightening expected at the next meeting on 22 August, it is our view that the US is very close to the cyclical peak in short rates.
Since mid-May, technology-related stocks have recovered strongly, and now look to have discounted a significant amount of good news. Hence, in recent weeks we have begun to reduce our exposure to stocks where valuations have become demanding. For example, our investment in the fibre-optic play Avanex has been reduced after some very strong performance.
On the buy-side we have increased the portfolio's exposure to selected, lower growth companies including Pepsico, the energy company Coastal, and therapeutic medical device manufacturer Guidant.
Looking ahead our view of US equity prospects is positive. The key underlying trends of rising productivity, low inflation and rapid technological innovation, which have underpinned the phenomenal performance of the US stock market in recent years, show few signs of diminishing. However, given the somewhat extended valuation basis of the market, and the fact that the cyclical component of corporate earnings will decelerate over the next six months, we expect equity returns to be lower than seen in recent years.
Moreover, stock selection is becoming increasingly important. While new economy stocks remain a key focus, especially in the areas of hardware and infrastructure, there is no doubt that the broad momentum seen late last year has given way to a more discerning approach by investors.
As time has elapsed, it is increasingly more apparent which business models provide the basis of sustainable competitive advantage over the longer term, as opposed to those where the underlying business metrics were perhaps left to one side in the rush to tap the public capital market.
Given our interest rate outlook we expect to continue to add to the portfolio's exposure to financials. We remain overweight in entertainment and media, areas of the market which historically perform well at the peak of the interest rate cycle.
We are currently underweight in consumer stocks, where the trading environment is difficult, and in the short term we expect healthcare to underperform as the risk of post-election legislative changes are brought into greater focus.
Tim Scholefield is director of global equities at Royal and SunAlliance Investments
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