Low inflation, strong economic growth and strong equity markets. This Holy Grail of prosperity, whic...
Low inflation, strong economic growth and strong equity markets. This Holy Grail of prosperity, which seemed within grasp during the first quarter of 2000, faded away through the remainder of the year.
The S&P 500 fell 13.2% and the Nasdaq 42.5%. Economic growth, which peaked at the end of the second quarter, is now trending lower with economists expecting a significant slowdown. The only good news is that inflationary pressures appear to be receding, but even this is threatened by high energy costs.
Subtle and not so subtle shifts in investor behaviour developed during the past year. Appetite for tech stocks waned and turned towards stocks such as utilities, beverages, and energy and pharmaceuticals.
Rapid revenue growth and exciting new business models, coupled with an extended run of economic prosperity, had caused the risk tolerance of many investors to increase so much that many companies were able to raise finances through the markets without much of an operating track record.
This level of confidence was significantly damaged in March when fears of inflation started to loom larger. Economic growth was strong and employment and wage pressures were building. This caused the Federal Reserve to raise interest rates three times from February to May, with a final increase of 0.5% rather than the customary 0.25%. This eventually slowed the economy down, as reflected in scaled back corporate profit forecasts. Growth sectors have been particularly affected, as their prospects are sensitive to the outlook for the economy.
The general consensus among economists, and the Federal Reserve, is that the economic slowdown is now more of a concern than inflation.
The key issue for the US equity market is whether a soft landing can be achieved and inflation remains subdued. With regard to growth, changes in consumer spending have been closely correlated to movements in the Nasdaq index and so it remains to be seen how much spending will slow in line with the Nasdaq volatility.
Many companies have announced disappointing corporate profit results. We are already seeing organisations announce that fourth quarter profits will not meet expectations but this may represent caution as a result of new disclosure rules.
Flows into equity mutual funds have continued to remain at good levels. The decline in share prices has caused valuations to fall to more reasonable levels.
A favourable bond market and the lower interest rate may be enough to offset investor worries over corporate profit growth.
This being said, the macro outlook is difficult to foresee. On a company level, it remains important to evaluate potential investments on both a fundamental and valuation basis, as investors have become very discerning.
Adam Smears is a fund analyst at Fidelity
Despite improved risk appetite
FOS award limit increase
Relates to 136 million transaction reports
Ceremony will take place 13 November