By Martin Robertson, fund manager, at Abbey National Asset Managers. The events of 11 September ...
The events of 11 September are etched on the public psyche and fund managers have been in reflective mood, too. Is this human tragedy a disaster for the economy, or is it the catalyst that decision-makers need to adjust monetary and corporate strategy to ensure a speedy return to normality? Will normality ever actually return?
Not unexpectedly, the initial reaction of portfolio managers was to go for safety, while, at the same time, a much higher equity risk premium was demanded. It was no surprise to see pharmaceutical and food firms among the top performers, with airlines and hotel companies rooted at the bottom.
As the Allied campaign started, analysts scoured historical charts looking for the markets' reaction to previous crises. Military events such as the Gulf War and Pearl Harbour were compared with mere financial crises, such as the one in Asia in 1998, but the overriding conclusion was that, on average, markets were at higher levels within three to six months. Global markets experienced a strong bounce, with portfolios buying as much beta as possible.
Prior to events in the US, we had been assuming a gentle economic slowdown in the third quarter of this year, followed by reasonable recovery in 2002. We believed that published expectations of company profits were too high but that market valuation metrics ' the bond earnings yield ratio in particular ' were discounting this.
By mid-year, we had started inching the portfolio away from our defensive bias as we were prepared to take on slightly more risk. Although this strategy hampered performance in the immediate aftermath of the terrorist attacks, the subsequent market rally more than outweighed the initial setback.
We believe the probable outcome in continental Europe is a lower trough in the economic cycle than previously thought, perhaps flirting with recession ' although this seems less likely than in the US. This will lead to a larger than expected monetary stimulus from the ECB ' hence, although from lower levels, the bounce in the economy will be more pronounced.
A similar scenario can be foreseen in company earnings, which will cause an acceleration in corporate restructuring, and so the market should start to discount a recovery in profitability. This will come at a time when company earnings forecasts have already been cut significantly and, if anything, are still likely to require further trimming. So traditional earnings valuations may look stretched.
Interestingly, recent profit warnings in non-defensive sectors have been greeted with strong share price performance ' in short, the market is anticipating earnings downgrades.
We have not reversed our post-11 September view and have continued to shift the portfolio towards those firms that will benefit most from economic recovery. We believe the market will continue to move our way, particularly as those funds that were cyclically-oriented prior to 11 September are unlikely to reverse the position, while those that were defensive are unlikely to become more defensive. Either way, a pro-growth strategy looks best.
Recovery steeper than originally thought.
Equities cheap relative to bonds.
European assets cheap due to euro devaluation.
Uncertainty regarding potential attacks.
High risk premium built into equities.
Earnings could be much worse than anticipated.
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