Fund manager's comment/Steve Cleal
'Sell in May and go away' is one of the oldest mantras in the fund managers' training manual. Investors who heeded this advice in 2001 will, by now, be feeling fairly pleased with themselves. At the time of writing, the broad index of UK shares was nearly 10% below May's high. US share prices have also headed south.
What has caused markets to fall? A constant flow of high profile companies warning that profits will be well below analysts' expectations hasn't helped. The fact that some of these expectations were unrealistically high to start with doesn't matter. The painful truth is that investors have been forced to reconsider the economy's ability to generate a rapid increase in profits over the long term.
The downturn in the global economy means that corporate profits will continue to struggle over the coming months. How will companies respond? The nimble ones will attempt to reduce costs. One area where savings can be made is investment spending. Activity in this area has already turned down sharply and, with demand remaining weak at home and abroad, US companies will continue to pull in their horns.
Further cost savings can be made by trimming staffing levels. Recent modest rises in claims for unemployment insurance in the US suggest this process has begun, but many more lay-offs are in the pipeline.
These headwinds mean the US economy could remain weak over the coming months. Although signs of an economic recovery are likely to emerge later this year, in response to the 2.75% reduction in interest rates, growth rates in 2002 will compare unfavourably with the strong burst of activity recorded in the late 1990s. US share prices and the dollar could perform poorly and an underweight exposure to Wall Street seems appropriate.
European equities should perform better. The global downturn in demand will adversely impact European growth but the Central Bank (ECB) has the potential to offset these pressures by easing interest rates.
So far, the ECB has been reluctant to loosen monetary policy for fear of exacerbating inflationary pressures. However, the Euroland economy is better balanced than the US, which has a massive burden of private sector debt built up during the boom years. We are optimistic that interest rates will be cut.
Turning to Japan, the newsflow is not expected to be good. Recent indications are that growth is slowing again and, because interest rates are already at zero, the scope for official intervention is much reduced.
The new Prime Minister has a mountain to climb if he is to halt the deterioration in bank's balance sheets. Although any improvement in the performance of the economy would come as a positive surprise, a neutral weighting in Japan relative to benchmark is probably the safest bet.
Interest rates have come down sharply.
Equity markets now offer better value.
Recovery is expected around turn of the year.
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