During the third quarter of the year, the Dow Jones Industrials managed a rise of 1.9% but the S&P50...
During the third quarter of the year, the Dow Jones Industrials managed a rise of 1.9% but the S&P500 fell by 1.3% and Nasdaq by 7.4% (all in local currency terms). The Dow Jones has lost 7.4% over the year to date and the S&P500 and the Nasdaq some 2.2% and 9.8% respectively. The diminishing prospects of an interest rate increase this year continued to produce strength in the interest rate sensitive sectors and the Dow Jones Utilities index has gained 41% in 2000.
Financials were also helped by the Chase Manhattan bid for JP Morgan. The sharp rise in the oil price led to further strength in energy stocks. Evidence of a slowdown in the economy, however, led to continued weakness in cyclicals. Technology stocks continued to decline despite excellent second quarter earnings.
Sixty S&P500 companies have so far preannounced that earnings will fall short of expectations for the third quarter versus 37 at this point in 1999.
Energy costs, slowing retail sales and the weak euro, are cited as the most common catalysts. Many of those making the announcements have little revenue growth which has been exposed by these other factors. As compared to six months ago, when the economic background was very strong, the greatest upside revisions are in the energy sector while transportation, consumer durables and basic industries have suffered on the downside.
Little has changed in perceptions of the earning prospects for technology, healthcare and financials. Indeed, although a few sectors are being modestly squeezed by rising costs and less robust demand, profit growth is still very solid. This quarter only appears disappointing in comparison with the previous period of very exceptional profit growth.
The S&P mid and small cap indices have strongly outperformed the S&P500 for the quarter and the year. Much of this outperformance can be explained by their higher exposure to utilities, financials and capital goods and their lower exposure to technology and communication services. In addition, their components are more domestically oriented and have less exposure to the euro. As the US economy slows this domestic orientation may be less helpful.
Alan Greenspan has stated "there is no credible evidence in the United States that the rate of structural productivity growth has stopped increasing" and these comments imply the Federal Reserve can accept faster growth and a tight employment market with much less fear of increasing inflationary pressures than in the past. in addition, much economic data confirms that growth is plateauing. As a result, the consensus now expects no further change in interest rates this year.
On balance, the economic statistics show the economy is slowing, not least as a result of Fed tightening, the rise in energy costs and a deceleration in consumer spending. Indeed, the September National Association of Purchasing Manager's figures are consistent with an orderly slowdown and the fall in its delivery delays index, closely watched by Greenspan, implies capacity constraints may be easing.
Thus, inflationary pressure and, therefore, the propensity for the Fed to tighten is lessening as highlighted by the recent decline in retailers' pricing power and the slowdown in PPI core measures.
High energy prices should not have the same negative impact on equities as in previous cycles. Previous periods of rising oil prices provoked a contractionary policy response from the Fed. We doubt this will occur this time. Furthermore the sensitivity of profit margins to rising fuel costs is less than the consensus expects as only a few industries consume large amounts of energy per dollar of output.
The opinion polls show that the presidential race is very close. On the other hand, there are concerns about the possible lax fiscal policies of both candidates. it should be borne in mind, however, that platforms and promises rarely become programmes. The winning candidate's priority will be reelection and, therefore, the continuation of low inflation and sustainable growth. Profits and interest rates are likely to be more important stock market determinants.
In recent years, the third quarter has proved generally weak whilst the fourth quarter has been the strongest. Part of the third quarter downswing can be explained by the timing of the year's busiest period for downward earnings revisions as corporations face the reality that meeting ambitious annual targets has become difficult with the calendar year end approaching.
In addition, inflows to mutual funds are generally low in the summer.
Correspondingly, the fourth quarter sees significantly fewer cuts to profits and recognition that a new year of earning opportunities awaits. Fourth quarter mutual fund inflows also have shown a 20% sequential increase in recent years with an average of a 50% first quarter jump waiting in the wings.
The outlook for interest rates is clearer and the prospects for inflation are constructive. Following the earnings increases of recent quarters and the overall decline in the large cap indices, valuations are much less demanding.
Earnings growth is moderating but remains healthy, with the likelihood of around an 11% increase in 2001 despite demanding comparisons. In addition, market breadth has improved and just over half of S&P stocks outperformed the index in the third quarter, compared with significantly less than half in every year since 1993.
Turning from the US to Japan, the Japanese market, as measured by the Topix index, fell 7.6% in yen terms and 5.7% in sterling terms, given yen strength during the third quarter. The smaller companies Jasdaq market fell 16.9% in local terms.
Outperforming sectors included oil, optical fibre, and communications sectors. Underperformers included the tyre/rubber (given Bridgestone's US problems), retail, and numerous domestic cyclicals sectors suc
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