While economists debate whether the US economy will experience a mild short slowdown or a more prolo...
While economists debate whether the US economy will experience a mild short slowdown or a more prolonged recession, there is no debate necessary about whether US companies are in a profits recession. S&P 500 earnings growth estimates for 2001 have fallen over the past eight months from a high of 14% to 0%, with outright earnings declines anticipated in half of the S&P sectors in the next few quarters. This estimate may turn negative as we are faced with another round of negative earnings pre-announcements in March.
With the economy clearly decelerating, earnings growth slowing and overwhelmingly negative newsflow, investors might believe there are few reasons to remain positive on the US. But aggressive easing by the Federal Reserve, proposed tax cuts, accelerating monetary growth, lower mortgage rates and the re-opening of the high yield market should all support the economy in 2001 and put it back on the path to growth in 2002.
Another positive signal is that earnings expectations have become more reasonable and the pace of negative revisions may have slowed after experiencing nearly the worst period in earnings revisions over the past 20 years. Historically, negative earnings revision trends have hit their trough about three months after the Fed's second rate cut and S&P earnings growth has bottomed six to nine months after the second rate cut. This would imply a trough in the second or third quarter of 2001.
While further estimate cuts may occur, the rate of change in revisions should become more positive and we expect this will mark a bottom in the market.
Another catalyst to watch is the rate at which companies can clear out excess inventory. While companies benefited over the last several years as just-in-time manufacturing and supply-chain management helped reduce costs, these same productivity tools should help reduce the length of time necessary to clear out inventory. Many companies are cutting capital expenditure budgets aggressively, deferring new investment projects and laying off staff.
All of these measures, while painful in the short term, are positive steps towards future earnings growth. Industry leaders use these times to distance themselves from their competitors by re-investing in their business and lowering costs.
We expect the positive catalysts to win, although it is unclear when exactly this will occur during the year. Ultimately interest rate sensitive sectors such as technology will benefit, probably to the detriment of more defensive sectors. Many of these interest rate sensitive stocks may be poised for a rebound, especially companies with proprietary products and clear market leadership that have participated in the market decline to the same extent as companies of lesser quality.
Susan Everly is manager of the Credit Suisse Transatlantic Fund
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