The Federal Reserve is raising US interest rates to levels unseen since 1991, when the economy was c...
The Federal Reserve is raising US interest rates to levels unseen since 1991, when the economy was coming out of recession. Are the halcyon days of low inflation, moderate growth, and high productivity coming to an end?
On balance we think not, but it is becoming a riskier call. The US economy continued to power ahead in the second quarter, but the effect of 175 basis points of interest rate tightening since last June should materially cool the US economy in the second half of 2000.
Monetary policy is a slow working tool, especially when used against a backdrop of such prolonged irrational exuberance. We do detect signs that the economy is beginning to slow in leading indicators such as housing starts, retail sales and NAPM surveys. On balance we believe the Fed will engineer a soft landing but the probability of failure has increased.
The background for the US equity market is still troubling. The benchmark S&P500 index is still only 8% off its all time high, and at 25 times 2000 corporate earnings. The technology-dominated Nasdaq has corrected, slumping over 40% since its March peaks, and is struggling to find a base.
In our portfolios, we are positioning for a higher interest rate peak than presently expected. Our favourite sector at present is healthcare, more specifically the drug industry. A return to the stability of reasonable growth at a reasonable price is expected, after the excesses of the growth at any price mentality seen in many dot.com and internet related stocks. Our research analysts have identified key stocks that should provide higher than expected earnings growth through 2001, and are selling at reasonable multiples compared to still hyped mainstream technology stocks.
In the technology sector our research analysts have highlighted their top recommendations based upon dominant market positions, strong industry growth and non-excessive valuations (a very subjective operation). We have moved the portfolios back to a neutral position from slightly underweight using these names. We are not trying to second guess the volatility of this sector, but believe internet technology changes everything, and are happy investing in companies that our analysts rate as being the next Microsoft or Cisco.
One sector on which we are quite negative is consumer cyclicals. This is one area of the economy where the Fed really needs to see results. In particular we are underweight high multiple 'growth' retailers. Many large US retailers are inappropriately labelled as growth companies, and valued as such. When the law of large numbers and a consumer slowdown doubly bites, we expect that these companies will be de-rated from their present lofty levels. We are also neutral on financials.
David Finch is head of US Equities at AXA Investment Managers UK
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