By Alex Ingham, head of North America equities at Aberdeen Asset Management The second quarter s...
By Alex Ingham, head of North America equities at Aberdeen Asset Management
The second quarter saw the S&P 500 index produce its best quarterly return since the fourth quarter of 1998 as investors drove a sharp post-war relief rally.
While the market was buoyed by the end of the war in Iraq, investors also factored in an improving economic and corporate environment during the second half of the year. This was led by a bounce back in industrial production and capital spending.
Coupled to this is the accommodative behaviour of the Federal Reserve, which has recently cut interest rates by another 25 basis points to leave them at 1%. Further tax cuts are expected from the Bush administration, which should help both corporations and consumers, although the stimulative effect may be diminished by weak budget positions at the state level.
Across the economy, profits and free cashflow have improved substantially and corporate balance sheets are under less pressure. With inventories at extremely low levels, any increase in demand will help profitability.
The majority of companies beat earnings expectations during the first quarter and are likely to do so again during the second, partly as a result of analysts lowering their forecasts. After two good quarters, there is a risk expectations may be raised too high and there will be a setback in the market if these targets are not achieved.
For this reason, we are cautious on investing in many of the stocks in the market as their valuations look stretched. From a global perspective, the S&P 500 is not cheap.
There has been much debate about the P/E multiple on which the market is trading. Estimates have ranged from 18 times to as much as 40 times. Our view is the market cannot support a forward P/E much higher than 19-20 times. Consequently, we have been focusing on companies trading below a market multiple that are geared into an economic recovery.
However, the strength of the recovery may continue to be erratic due to several factors. Capital spending budgets may grow slowly as capacity utilisation is still below historic averages and many companies are having to divert free cashflow into underfunded pension plans.
Our principal area of concern, however, continues to be the US consumer, with some signs of weakness in retail sales and slowing wage gains.
Recent headline employment data has also been disappointing, with the unemployment rate rising from 6.1% in May to 6.4% in June. However, this is not necessarily a signal of weakness as the rise was a consequence of more people looking for work. Furthermore, the decline in layoff announcements in May and June may mean stronger net job creation in the third quarter.
Overall, we expect to see a strengthening recovery through the rest of 2003 as corporate capital spending improves and consumption softens, supported by tax cuts and low interest rates. This leads us to a pro-cyclical stance with overweight positions in industrials and underweight positions in consumer-related areas.
Profits and cashflow improving.
Underlying employment data positive.
Accommodative Federal Reserve.
S&P index is not cheap at resent.
Capex budget may only grow slowly.
US consumer showing signs of weakness.
To promote 'long-term investment'
Switching 'hard and expensive'
Smaller funds still packing a punch
To drive progress