Fund manager's comment/Tom Elliot
Despite liquidity injections, the global economy is unlikely to recover until earnings expectations improve. History shows that eventually, falling interest rates will trigger a sustained rally in equities, but how long do we have to wait in this cycle?
In May, the subdued behaviour of equity markets since the April rally suggests that investors are not yet convinced that the factors behind the very weak markets in the first quarter have gone away. This was despite another 50bp cut from the Federal Reserve, and the potential for further reductions, and a belated 25bp cut from both the European Central Bank and the Bank of England, which demonstrated central banks' determination to provide enough liquidity into the global economy to avoid a recession.
Behind this lack of investor conviction lies continuing concerns over what the second quarter reporting season might reveal, given that there has been little evidence of an economic recovery in the US. Indeed, in Continental Europe and Japan, the domestic demand picture appears to be getting worse.
The US economy continues to dictate global growth prospects. While first quarter GDP was unexpectedly robust, expanding 2% at an annual rate, manufacturing remains in recession and the slowdown appears to be spreading to the service sector. Furthermore, unemployment posted a far larger than expected decline in April, driving up the rate to 4.5%.
We do not anticipate much progress on the major stock markets until the second quarter results begin to come out. We will be scrutinising the accompanying trading statements to see if there is any glimpse of a recovery in final demand, which, particularly in the IT sector, is being significantly affected by a fierce inventory correction as well as the postponement of capital investment.
The key sign of a genuine turn in investor confidence will be when share prices start to react positively to company results and statements. For this to happen, the results need to start exceeding expectations.
The other vital consideration is the point at which US quarterly profits might turn positive year on year. According to IBES, the market expects this will take place in the fourth quarter, but we feel this prediction may be a little optimistic. It should be noted that the US stock market discounts such turns by six months or so, suggesting that a genuine turn in global stock markets may occur at some stage in the Autumn.
If that is the case then any weakness in markets should be regarded as an opportunity to buy equities. As to which markets, a prime consideration must be where the greatest monetary stimulus is likely to occur. In current circumstances, this favours the US, UK and the Pacific region.
Rate cuts should trigger recovery.
Buying opportunity from equity weakness.
Central banks keen to avoid recession.
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