In the wake of the corporate scandals and gloom about the US economy felt by investors at the start ...
In the wake of the corporate scandals and gloom about the US economy felt by investors at the start of last year, one might be forgiven for taking a pessimistic approach towards the equity market.
The S&P 500 index fell by almost 25% last year and every one of the 10 broad market sectors ended the year down.
The index is now 43% below the all-time high reached in March 2000 as investor sentiment plumbed new depths during the course of the year.
Yet in spite of this despondency in the market, there was a surge of strength in the final three months of the year. Although some of this was subsequently given up in late December, we still believe the outlook for the US equity market has improved and expect to see further strengthening this year.
We have had three consecutive years of lower equity markets but we do not believe we are in for a fourth.
One year ago, investors were looking for economic recovery, only to be disappointed as the year progressed.
This year, the consensus is already cautious.
Investors are not expecting much in the way of positive newsflow in 2003 and share prices reflect this. Any surprise is therefore much more likely to be on the positive rather than the negative side.
Early and aggressive monetary and fiscal easing from the US government has successfully reduced the risk of a double dip.
We are expecting a gradual economic recovery rather than anything racier but this is still a supportive environment for equities.
Sales and profits are finally recovering. In the technology sector, where sentiment has been most negative, Microsoft recently reported sales growth of 25% and online auction giant eBay announced revenues had doubled in 2002.
The general trend is improving.
In an environment of improving fundamentals, the mere absence of further bad news would improve sentiment.
The wild card is the prospect of a war with Iraq but all the indications are a conflict would happen early in the year and be over quickly, removing a significant depressant on valuations.
Valuations are not exactly cheap at approximately 17 times forward earnings but are in line with historical averages for the current rate of inflation and interest rates.
Valuation compression has been the major driver of the market over the past three years.
We believe this has run its course and that earnings surprise will be the next major market driver.
Our central expectation is for a gradual recovery in both the US economy, corporate profits and equity market as the year progresses.
Our investment focus is on companies able to deliver strong relative earnings growth in what we believe will be an improving but still challenging environment.
The consensus is overly cautious.
Outlook for economy and profits improving.
Lack of bad news will mean positive surprises.
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