Fund manager's comment/James Abate
Most firms in the S&P 500 reporting second-quarter results have surprisingly exceeded analysts' consensus expectations.
Estimates had obviously been lower recently but these results do point to the fact that the stock market seems to have already discounted the current profit weakness, limiting further downside risk but waiting indefinitely for clarity on future quarters.
The US Congress is in the midst of its August recess, leaving issues on trade, healthcare and energy on hold until its return. Even the Fed, which meets again on 21 August, has only a few of its members giving public appearances during the summer.
Wall Street is not usually renowned for patience but perhaps that is exactly the attribute investors should display at this point in time. Specifically, investors should be trying to identify the one or two dominant themes that will drive outperformance for the remainder of the year. They should use these moments to add into weakness and sell into strength portfolio stocks that fit or conflict with those themes. Unfortunately, most analysts continue to believe that a final, climactic sell-off will occur, marking the bottom of the cyclical bear market. But because everyone expects this to happen, it probably will not occur. We are more likely to see the market bounce up and down until a significant catalyst emerges.
The one theme I believe will emerge and provide a positive boost to financial assets this year is a further reduction of inflation. The focus on timing the recovery in corporate profits is clearly critical but just as important is the fact that interest rates and risk drive the price of financial assets. So, excluding the issue of when earnings will stabilise, investors would be well served to identify how portfolio holdings will fare from further slaying of inflation.
This will not be a smooth ride as recognition of falling inflation will sometimes give way to anxiety over the spectre of deflation. This is unlikely to happen in the US, however, because the over-investment phenomenon has been confined largely to the technology and telecoms industries.
What gives me the confidence that there will be a further decline in inflation and long-term interest rates? Raw material prices and food prices are low and only going to go lower. Globalisation of the world's economies has created export-oriented developing world countries where cheap and abundant products, services and raw materials are pouring out of the system. At the same time, in the key industrial countries, wage growth has ebbed for the first time in many years due to accelerating layoff anxiety. So, despite continued profit apprehension, the US stock market will benefit from a further decline in inflation without much risk of deflation.
Now is the time to own firms that hold dominant market share positions within industries as pricing flexibility will erode in a low inflation environment.
• Many Q2 results better than expected.
• Further reduction in inflation likely.
• Raw material and food prices low.
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