Fund manager's comment/Jason Whitaker
It risks understatement to say that the past year and a half has been a volatile time for financial markets in the US. After the technology 'bubble' finally burst in March 2000, equity markets went sharply into a retreat that lasted at least until 4 April this year ' and may not, in fact, be over.
There has been considerably more uncertainty in US markets over the past 12 months than for several years. Despite this, there are plenty of data points for market commentators to grapple with and with which to construct plausible arguments. This has led to a cacophony of opinions ranging from mundane to extreme.
Starting with the bad news, there are a number of excesses from the past few years that need to be worked through. Most notable is the very high level of private sector debt, which has been rising as companies have borrowed to finance large investment programmes and share buybacks, while consumers, encouraged by stock market gains, have been spending more.
The US is also running a very high trade deficit, which in part is a function of the profligate consumer, but is unsustainable. Overcapacity exists in certain industries, caused by overinvestment in recent years. Now that the US is facing an economic slowdown, many of these factors are contributing to a sharp slowdown in earnings growth.
On the more positive side, the US still has a great deal going for it. First and foremost, there can be little argument that, in aggregate, US companies are extremely well run and are 'leaner and meaner' than companies in any other region of the world.
The supply/demand imbalances (overcapacity) in the US economy have occurred in the best possible sectors, technology and telecoms. Depreciation schedules in these industries are generally very fast and excess assets will be written off as obsolete in a few years. This is in direct contrast to the situation in Japan at the end of the 1980s where the overcapacity occurred in assets such as property.
We are moderately optimistic for the 12 to 18-month outlook. If the economy is in recession, it is likely to be mild. The Federal Reserve cut rates by 50 basis points in May after its surprise 50 point cut in April, bringing the target rate down to 4%, a full 2.5% lower than at the start of the year. This signals that the Fed intends to remain aggressive in fighting slowing growth. The market expects further rate cuts, which seems probable.
Given the rate outlook, a cyclical recovery is likely to begin by the end of the year and the sharp decline in earnings growth should have moderated by this time. In terms of earnings, it is likely that the second quarter will mark the bottom, although a true profit recovery may not be in place until mid-2002 for many companies. This would be consistent with improved market performance for the remainder of the year, given the anticipatory nature of the market.
Interest rate cuts still to take effect.
US companies remain extremely competitive.
Likely cyclical profit recovery by year-end.
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