The UK market continues to be dominated by events on Wall Street as investors worry over the effect ...
The UK market continues to be dominated by events on Wall Street as investors worry over the effect the US slowdown will have on UK companies. The tech-laden Nasdaq has seen unprecedented volatility, torn two ways by the deteriorating business outlook and hopes that interest rate cuts will help the ailing economy.
The real concern is how far the technology downturn is affecting the economy as a whole.
The recent US boom has been fuelled, to some extent, by the investment, jobs and wealth created by technology spending.
The downturn in the sector is bound to have much further-reaching consequences on the wider economy. This is already being witnessed in the job cuts and expense freezes at many investment banks, whose pipeline of highly profitable IPOs has almost totally dried up. The knock-on effect of higher unemployment and lower wages is a real threat to the economy's health.
It is this economic background that is causing the slew of profit warnings from many of the world's largest companies, both within technology related sectors and outside them.
The fall in stock prices, as a result of lower earnings expectations, has addressed the valuation extremes that were so prevalent in the market last year. Some of the irrationality has been taken out of the market, which has created an ideal environment for the stock picker. Given the generally downbeat sentiment, and the possibility that earnings estimates may continue to fall, the emphasis has returned to company fundamentals, rather than the hopes and expectations that were driving markets last year. It is now crucial to focus on companies with limited downside risk, which are in the least danger of issuing profit warnings and shocks.
We believe the time is right to be cautious but not defensive, since few defensive companies are attractively valued in relation to their growth prospects. It traditionally takes 9 to 12 months for interest rates to feed through into the real economy, and until that point, demand and business confidence may deteriorate further, affecting company earnings.
Profit warnings are likely to continue to flow from the technology sector and from other areas of the economy. It is too soon to say whether the recent rally in the UK stock market is sustainable, and it may yet turn out to be a dead-cat bounce. However, a trend seems to be emerging whereby negative news has left markets relatively unmoved, while good news has sent them soaring.
There are signs that investors are becoming more positive and that the bad news may be priced into markets.
Robert Moss is a UK Fund Manager at Invesco Asset Management
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