merrill lynch claims the market is not well placed to take advantage of economic recovery
The UK market is poorly placed to benefit from a recovery in 2002, according to Merrill Lynch.
It argues that on a global basis, the All-Share is overweight defensive sectors, a key reason it has performed well during the recent market correction, but underweight cyclicals.
In addition, it suffers from too much stock concentration with the 10 largest companies making up 45% of the index, according to Matthew McKelvey, member of the global equities team which manages the Merrill Lynch Global Titans fund.
As of the end of December 2001, the UK was overweight the MSCI World index by 6.7% in energy, 5.6% in financials and by 2.2% in healthcare. In contrast, it was 5% underweight industrials and 12.5% underweight the IT sector.
McKelvey said: 'Companies are increasingly global and so research at Merrills is carried out on sector lines. The top down approach is becoming less appropriate on a geographic basis.
'World competition means a lack of pricing power so the leading firms dominate their industries. Dell, for example, has the lowest cost model and aggressively competed in price in the downturn against Compaq and Hewlett-Packard.'
He argued that any ongoing global economic slowdown may well accelerate corporate Darwinism. In such a survival of the fittest environment, he predicted large companies would have the scale to benefit from a diversified revenue stream and to withstand economic stress.
This would also give companies the resources to develop products and stretch their competitive advantage, while exploiting growth opportunities around the world.
Merrills is slightly defensive in its outlook at the moment but it is looking to more economically-sensitive stocks, such as Rio Tinto in the mining sector. Within technology, media and telecoms, it favours media, believing this will gain from advertising in any economic bounce back. Within financials, it is cautious on banks but has increased its weighting to insurance.
The group's outlook for 2002 is for equities to outperform as economic recovery begins, although McKelvey warned consensus earnings expectations may be disappointed.
On the positive side, interest rates are low and so too are oil prices. There is fiscal stimulus for the economy and inventory adjustments. On the negative side, there is synchronous global slowdown, rising unemployment, valuations are not cheap and there is still a capacity overhang. According to McKelvey, capacity utilisation in the US still runs at only 74% and, as a result, the markets should expect less corporate spend than would normally be the case at this point in the economic cycle.
If equity valuations are not cheap, McKelvey said global blue chips are now looking comparatively good value compared with where they were two years ago. At the end of 1999 the average P/E of the top 100 largest stocks in the MSCI World was 49 times, against 31.15 times for the index excluding the top 100.
By the end of 2001 the figures had come down to 20.4 and 21.06 respectively, the result of liquidity being withdrawn from the largest companies, according to McKelvey.
The £156m Global Titans fund has established itself in the second quartile of the Autif Global Growth sector over the 12 months to 30 January.
In that period it is ranked 47 out of 156 funds, according to Standard & Poor's, with negative offer to bid returns of 20.8% compared to a sector average of -22.8%.
Over the three months to that date, on a bid to bid basis, the fund is up 3.6%, earning it a ranking of 66 out of 167 funds.
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