Doubts over economic growth, earnings warnings, five-year no-interest deals on car purchases and a m...
Doubts over economic growth, earnings warnings, five-year no-interest deals on car purchases and a mortgage-refinancing boom. No, I haven't dusted off some notes from 12 or 18 months ago, these were all features of the US equity market in the first quarter of this year.
When we add to these the war in Iraq and severe weather in much of the US, a flat year to date tells us how much has already been priced into equity markets.
While the market initially rode a wave of optimism, fuelled by reasonable earnings numbers in the fourth quarter of 2002, we have seen a slew of earnings downgrades as this quarter has progressed.
These have been quite widespread, with all sectors except energy, which is benefiting from booming prices, and financials, driven by brokers, experiencing earnings downgrades for the year.
As usual, analysts are not downgrading earnings numbers in a vacuum. We have seen a significant number of companies pre-announce earnings for the first quarter, with a ratio of three negative pre-announcements to every one that is positive. This is the most negative ratio in five quarters.
The most overused excuse for earnings misses will be the severe weather in the early part of the quarter and the war for the latter part.
This has thrown up some interesting anomalies, such as the difficulty soft drinks distributors have had in delivering their product in the poor weather, while beer company volumes have been less impacted.
I suppose that is the difference between a consumer staple and a necessity.
What we have not heard given as often as an excuse is that the economy just continues to be tough, hampered by excess capacity while consumers are being rationally price sensitive.
We think these factors are at the heart of the current earnings problems and that investors just got overly bullish on flimsy evidence at the start of the year.
Besides the impact on earnings the tough economy has had, there are issues to be resolved in terms of pension and healthcare benefits funding and possibly options expensing in 2004 and 2005.
However, we must not forget that the equity market is a discounting mechanism and that news soon becomes history, with those who see the glass half full gaining the upper hand.
As we look into the second half of the year, there is an expectation that oil prices will fall to a more normalised level, in the mid $20s.
In addition, while President Bush's wide-ranging and significant tax cuts will not get implemented in full, it looks likely there will be significant stimulus.
So how does one position portfolios for this environment? We have been reminded that quality counts. Disappointing news punishes cheap stocks as much as expensive ones, yet by definition one tends to get more disappointments at the cheap end of the market.
Energy prices are falling.
Fiscal stimulus from tax cuts.
Demographics promote demand.
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