For the first time in many years US investors have become increasingly concerned about the growing p...
For the first time in many years US investors have become increasingly concerned about the growing prospect of a hard landing. After five years of annual 20% plus appreciation, the S&P 500 has gone through a period of consolidation. Since it's high in March , the main US index has fallen 15%.
The real damage has occurred in the technology laden Nasdaq index, which is now down 49% from its high and 30% over the last 2 months. This constitutes the largest fall since 1971 and is reflective of several growing sources of concern for the US financial markets.
Although there was a uniform desire in the spring for the Federal Reserve to raise rates so as to slow the US economy, few were expecting the economy to slow so quickly. From 5.7% in the second quarter, interest rate increases, destocking and lower growth in capital investment spending contributed to GDP slowing to a 2.4% rate in the third quarter.
The corporate bond market has had a very tough year with spreads at recessionary levels. This has made it hard for companies with anything other than top quality credit ratings to obtain debt financing.
Equity market returns have been so poor that the new issue market has effectively closed for business for the rest of the year. In addition, venture capitalists are no longer throwing money at technology companies.
This has raised the spectre of the dreaded credit crunch. Bank of America admitted that non-performing loans rose in third quarter from $435m to $1bn. This combined with months of numerous profit warnings pushed investors over the edge and wholesale dumping of highly valued stocks, especially technology stocks followed.
Barring a speedy election result and a statement from the Federal Reserve at its December 19th meeting of its intention to move to a neutral bias, we believe investors may be giving up a year end rally.
Although trends have not been constructive, we expect the US economy to softly touch-down intact next year. The Federal Reserve has enough flexibility to rescue the economy from a credit crunch with several interest rate reductions if necessary.
Credit concerns should moderate. We expect the first rate cut in the spring, given that inflationary pressures should show signs of slowing as the oil price falls. At current levels many stocks in the US equity market are already discounting the worst. The tech bubble has well and truly burst and has been replaced with a growing sense of realism amongst fund managers.
As recent concerns subside in the first half of next year, fund managers will look back on stock market levels today as a great buying opportunity.
The recent switch into defensive sectors should unwind as investors rediscover confidence. Solid, if unspectacular earnings growth of around 7-9% next year will focus investors on stock selection over sector bets.
Terry Ewing, investment director, Britannic Asset Management
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