The second quarter earnings season in the US saw share prices fall despite consensus earnings announ...
The second quarter earnings season in the US saw share prices fall despite consensus earnings announcements.
This was because companies such as Microsoft were perceived to be stretching further and further to match expectations.
As investors looked to the next quarter, they became concerned over the durability of earnings growth, particularly when considering expectations of US economic slowdown.
The US equity market returns will be driven by the market's perception of Federal Reserve interest rate activity and the extent to which corporate earnings slow.
Although operating earnings growth for the second quarter remained above 20% year-on-year, they are likely to come under pressure as coming quarters yield tough year-on-year comparisons. While we do not see much upside for the market in the near future, we expect non-US earnings to mitigate, in part, the pressure on domestic profitability.
The economic situation in Europe continues to improve and valuations look attractive relative to short-term bonds. But the region would be hurt in the event of a US hard landing.
The profits growth outlook for 2000 and 2001 in the Pacific Basin is encouraging and valuations are reasonable, having fallen back since late 1999. A strong US dollar would be negative for the region.
In Japan, consumer confidence remains low and the equity supply/demand picture appears poor short-term. However, corporate profits growth is strong, despite the weak economy, and we anticipate an improvement in the medium term outlook
The UK equity market is subject to similar pressures as world markets, and we believe that it will become increasingly difficult for many firms to maintain margins in light of secular trends, notably the pace of technological advancement and the effects of increasingly globalised industries.
Cyclical factors are also contributing towards the trend to lower profits growth; interest rates have risen, while inflation is trending lower.
In this environment, we continue to favour companies, which are protected by sustainable competitive advantage, in areas where demand is expected to remain robust.
The healthcare, media and areas of the technology sector represent good examples of this. However, our views are balanced by the relative attractiveness of valuations.
Investors are now focused more on fundamental valuation criteria and we do not expect to see a return to the growth-biased, momentum-driven markets that we experienced during the fourth quarter of 1999.
As a result, we favour stock selection within sectors, in preference to adopting a significant style bias towards value or growth-orientated stocks.
Keith Mullins is manager of Mercury Balanced Portfolio
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