The start of the war in Iraq brought some relief to beleaguered equity markets, which had fallen pre...
The start of the war in Iraq brought some relief to beleaguered equity markets, which had fallen precipitously in the preceding weeks.
Uncertainty over the war's timing and duration had weighed heavily on investor sentiment, but the invasion prompted a sharp rally in equities. Early progress by US and British troops augured well for a brief war, and this supported the bounce back from market lows.
There is a precedent for such a move. At the start of the last Gulf War, global markets rose almost 20% during Operation Desert Storm.
In the near-term, markets will continue to trade on news about the military conflict. Of course, trading opportunities will present themselves, but making any near-term predictions about the direction of markets is all but impossible.
That said, war is not really the issue. In the longer term, once the fighting has stopped, it will be the underlying economic fundamentals that drive equity markets. And the fundamentals are not that great.
After a period of positive economic data, recent figures have been disappointing. In particular, poor US labour data raises questions over consumer spending, the mainstay of the US economy. Industrial production continues to improve, but a rise in input prices and sluggish final demand suggest an unfavourable outlook for profit margins.
We are also concerned about increasing imbalances within the UK economy, with the government deficit increasing at the same time as the current account deteriorates. Europe remains weak; due to the strength of the euro, monetary conditions are now tighter than they were before the recent interest rate cut.
So where are the opportunities? Not within consumer cyclical stocks. These are coming under pressure as the outlook for consumer spending has deteriorated. High levels of anticipated spending, factored into many profit forecasts, may prove unachievable as income growth and housing markets (both of which have supported the sector to date) begin to cool.
In contrast, industrial cyclicals in some regions appear to provide more opportunities. American companies look best. Industrial inventory levels are generally very low in the US, and corporate capital expenditure is now beginning to pick up. Many industrial cyclicals in the UK, on the other hand, have been assailed by concerns over pension scheme shortfalls.
The basic industries sector is generally perceived to be particularly sensitive to the economic outlook. However, in spite of the weaker backdrop many materials stocks have held up well in the last 18 months. One exception is chemical companies, where some have suffered from dramatic rises in oil-derived base commodities.
Given the uncertainty, investors are understandably attracted to companies in the market that can offer an attractive dividend yield and strong free cashflow (which provides the ability to buy back their shares).
Bond markets are unusually volatile, driven largely by war news but also by weaker economic data.
Volatility presents tactical opportunities.
Improved prospects for business spending.
Materials have held up well.
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