The year 2000 turned out to be a somewhat torrid year for equities. In fact it was so bad that in th...
The year 2000 turned out to be a somewhat torrid year for equities. In fact it was so bad that in the UK, it was the first time since 1990 that cash and bond returns both exceeded equity returns. Will 2001 prove to be a more profitable year for investors?
Last year certainly started well enough. A combination of strong US growth numbers and strong mutual fund inflows led to a continued surge in tech stocks. By mid-March however, it all came to a sharp halt.
Concurrently the US economy itself began to slow. Interest rates in the US had increased by 175 basis points since July 1999, which began to hurt the domestic economy. This also fed through to hit corporate profits in the US and Europe. The fourth quarter of 2000 was characterised by a steady raft of profit warnings from European and US companies, and at least half of these were technology companies.
With fears about a hard landing in the US increasing, Alan Greenspan surprised the market with a 50 basis point rate cut. But is this enough to allow the UK market to break out of the trading range in which we have been stuck for the past two years?
The bulls argue that interest rate cuts will be good for market sentiment and that the market will begin to anticipate economic recovery in the second half of this year. The other side of the argument is that the suddenness of the rate cut suggests that the US economy is actually in worse condition than generally expected. Recovery will therefore take longer and the logical conclusion will be another raft of profit downgrades. A further concern is that the last time the Fed cut rates between official meetings was in October 1998 during the global financial crisis. The key question is whether the market can look through the expected period of earnings disappointments on both sides of the Atlantic to economic recovery in the second half of the year.
What are the implications of all this for UK interest rates? Despite the slowdown in the US, UK economic statistics remain firm, helped by higher Government expenditure. UK base rates have been on hold since February and, unless the UK economy is suddenly affected by the US slowdown, we do not expect any change to current policy in the short term.
In summary, interest rate cuts alone are unlikely to be enough to allow a significant appreciation in the market. Investors will probably want to be convinced that the US economy has hit the bottom before the market can break out of its current trading range. We expect this to be the case later this year, and combined with high institutional cash levels and attractive valuations, this leads us to expect a positive performance from the UK equity market this year. Returns of over 10% are possible.
Karen Robertson is investment director, UK Equities at Standard Life Investments
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