We head into the spring of this new century with one of the main problems for US investors - the sco...
We head into the spring of this new century with one of the main problems for US investors - the scope of interest rate hikes - unresolved. Despite the 25 basis point rise early in February, we feel that there is another 50 basis points to come by the middle of the year. But the extent of the overall rise during the current cycle is still difficult to fathom, and this is causing great uncertainty in the market.
The booming US economy is the culprit. The worry is that economic growth is now running at unsustainable levels, and sooner or later inflation will take hold and turn boom to bust. The warning signs are already being seen in the labour market, which is now incredibly tight.
To the Federal Reserve, this is extremely worrying, as spiralling wage costs cause inflation. However, at the moment rising input prices (oil and gas prices have also been rising sharply) are not being passed on to the consumer, and instead are being absorbed by many companies through dramatic productivity gains, or otherwise in their profit margins. Ironically many firms are restructuring to increase productivity and this in turn is reducing job security and helping to keep wage pressures under control.
Meanwhile it is the mighty consumer that is leading the economy ever onwards. Consumer confidence is at a 32-year high and consumer spending shows no sign of slowing down. Certainly there is little evidence to suggest that the interest rate rises seen in the second half of 1999 have had any effect on the spending habits of the average American, and has failed to slow the economy down to more sustainable levels. However whilst inflation remains under control the stockmarket should be able to take comfort. But can it?
Worryingly the bond market has been extremely volatile, with the yield on 30-year Treasuries falling sharply so that the yield curve is now inverted. Although the fact that the restricted supply of new Treasuries by the government helps to explain this phenomenon to a certain extent, an inverted curve is usually a signal of impending recession and should be taken seriously.
Therefore, it may not be a coincidence that the areas of the stockmarket that have being doing well (apart from technology) seem to be those sectors traditionally viewed as being defensive when the economy slips. At the same time those sectors that are underperforming the most are the cyclical areas most susceptible to a sharp economic slowdown. In particular consumer cyclicals were down more than 13% in January, illustrating the bearish sentiment of investors to economically sensitive companies.
Interestingly it is technology that continues to power ahead. Unshaken by interest rate hikes, or by the threat of economic slowdown, investors continue to see the technology as the only sector worth investing in. Indeed, with such massive, and inexorable, profits growth forecast for the sector perhaps this is the sensible thing to do in the face of deteriorating macro-economic factors.
We continue to add to quality tech holdings in the Save & Prosper US Growth portfolio, whilst reducing exposure to areas where we think profitability will come under pressure. Our focus in the technology sector is to look for the most durable business models; companies that we believe can sustain a competitive advantage over the long-term.
As far as non-tech sectors of the market are concerned, much depends on the ability of the Fed to slow the economy to a more sustainable growth rate. Any overshoot, or undershoot, in the rate rises that are necessary to achieve this could spell the end for this current extended period of US economic expansion.
Antony Gifford is manager of the Save & Prosper US Growth Fund
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