The lack of overall market movement has masked a mind-boggling divergence in individual stock perfor...
The lack of overall market movement has masked a mind-boggling divergence in individual stock performance. Very generally, the best performers of the last three months have been financials and software stocks, while the worst are telecoms, media and a few old economy special situations.
Perhaps we should not have been surprised that September was so painful for markets. September is statistically one of the worst months of the year for both earnings downgrades and market performance.
Strategists have become slightly less negative over the last quarter, increasing their equity exposure. It must be emphasised that that still leaves them underweight, because in their view although the overall value gap between equities and bonds has closed, equities are still not cheap. My view is long-term inflation trends have bottomed but that the perceived severity of any potential bounce in inflation will probably be overdone regularly.
Structural forces are dominating cyclical influences in many industries. Two structural themes stand out and these are the growth of e-commerce and the existence of excess capacity. Margins are under pressure for companies without competitive advantage or barriers to entry and companies have little pricing power. Independent central banks now control inflation. Perhaps the biggest structural changes in the last decade has been the growth in global productivity that has been witnessed in the world, particularly the US. I believe it is sustainable and can rise further, due due to ongoing technological change, deregulation and globalisation.
The move to a more service-based economy also has profound implications. In particular, the internet helps participants allocate resources more efficiently with many businesses more open to international trade and competition. Barriers to entry are falling, distribution methods are changing and, in many industries, prices are set to fall. The absence of pricing power is all too apparent in many sectors. This is likely to be an extremely harsh environment for the majority of industries and companies and there will be fewer winners in a narrowly-based stock market performance.
Earnings upgrades have, on average, reached the peak of their cycle. Four profit warnings a day stateside show this all too clearly. Alan Greenspan has said "knowledge-based goods and services use relatively few physical resources to generate value." This is reducing one key scarcity constraint on growth - the physical availability of labour and resources.
We should, therefore, expect further substantial improvements in the trade off between growth and inflation due to productivity. The long-term outlook remains disinflationary due to technological investment and productivity growth. This fundamentally remains bullish for equity markets.
Richard Prew is the fund manager of the Norwich Union UK Equity fund
First mentioned in Cridland Report
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