By Suan O'Brien, head of the US desk at First State Investments The investment community has beco...
By Suan O'Brien, head of the US desk at First State Investments
The investment community has become increasingly confident that monetary and fiscal stimuli will spark a US recovery by the second half of 2002.
A primary emphasis in discussions over the state of the economy must focus on consumer demand and in the direction in which it is heading.
The reaction from the Federal Reserve has been encouraging. It has pumped a huge amount of liquidity into the economy, with rates now standing at 1.75%.
This is the lowest level in 41 years and the consumer is benefiting as mortgage refinancing reaches all time highs and floods of deals for 0% auto financing are on offer.
A near term recovery is evident through reports from a number of technology companies confirming some degree of increased demand, showing that the inventory build-up that has been such a problem throughout this year has largely been worked through.
Technology companies have a high degree of operational leverage due to the aggressive cost cutting measures applied since the slowdown began.
This ability to cut costs so aggressively is a feature of the flexibility of the US economy where employment laws allow extensive mobility within the job market, enabling companies to reduce staff to an extent that is difficult to match in other developed economies. Fortunately for many companies, corporate earnings estimates have been scaled down to such an extent that they have produced relatively undemanding targets for 2002.
The outlook, however, remains far from certain and we think that current market sentiment is overly optimistic. Unemployment levels are rising, and in turn the level of uncertainty among consumers is increasing.
Increased consumer spending has typically accounted for 45% of the upturn in financial markets during the first year of recovery and market analysts have forecast a 15% rise in S&P earnings for 2002. If the assumption of a surge in consumer spending is proved wrong, the recovery may be somewhat anaemic, and consequently this 15% rise in earnings will have to be sourced elsewhere in the economy.
The recent rebound in the markets has increased valuations to the point where the market is no longer cheap and a recovery is priced in. There will be a recovery in technology this year, but selected stocks have already reached very high multiples during the recent rally.
Any further significant upward move in stock markets in the short-term would be brought on only by data confirming a recovery; a market led higher by an economic recovery will see economically sensitive, cyclical stocks continue to outperform. Markets are also vulnerable to any bad news coming from individual companies. The updates provided to investors by companies early in 2002 will give a clearer indication of the visibility of recovery.
We continue to exercise caution, especially in the short-term run up to this wider series of company news announcements. Longer-term, the flexibility and resilience of the US economy is unrivalled.
Signs of economic recovery.
Liquidity is in plentiful supply.
Inflation remains under control.
Lack of earnings visibility.
Low 2002 consumer demand.
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