Few commentators would have predicted the unfancied US stock market would have established such...
Few commentators would have predicted the unfancied US stock market would have established such a clear lead over all other leading equities during the year to date. More surprisingly, who would have predicted the Nasdaq Composite Index, dominated by highly-valued mega-sized technology stocks, such as Cisco, IBM and Intel, would deliver a positive return over the same period?
The pattern of economic news is providing little support for this trend. Investment spending has remained in the doldrums, unemployment is edging upwards and manufacturing activity, which was showing signs of recovery, appears to be ebbing. Moreover, despite the continuing steady growth in real incomes, the pace of consumer-related activities, which have hitherto sustained the economy, is beginning to slacken.
House prices have remained solid, more than outweighing the impact of weak stock markets on household wealth. Low long-term interest rates have stimulated a strong trend in mortgage refinancing, a substantial part of which has been spent by consumers. Yet personal borrowing is high and consumer confidence has recently succumbed to the combined influences of rising oil prices and employment uncertainties. The Fed's latest Beige Book, produced in association with the FOMC interest rate setting meeting on 19 March, struck a distinct note of caution on the near-term outlook. Forecasts of economic growth in 2003 are being edged downwards to under 3%, but only a handful of economists predict a double-dip recession. This apparently anaemic rate of growth compares favourably with the near stagnation in the world's second and third-largest economies, Japan and Germany respectively.
Given this uninspiring economic newsflow and the continuing rumblings over corporate excesses and misdemeanours, how has Wall Street maintained its comparative resilience? It is not due to overseas buyers, who are proving reluctant to continue funding a rising Federal budget deficit. President Bush's action in announcing a larger than expected $674bn 10-year programme of tax reductions might be seen a mark of anxiety, especially in the light of news that GDP in the final quarter of 2002 was stagnant. It has been criticised for its long-term emphasis and his lack of a near-term boost for middle-class Americans. Investor confidence, especially among private investors, is depressed, with sales of cash-based mutual funds comfortably beating the net uptake for equities.
The next opportunity for this is in April when Q1 results are due to be announced. With the war in Iraq and the lack of clarity on the economy, prospects for an imminent improvement in newsflow appear limited. There is even scope for consumer confidence to suffer in the wake of heightened fears of terrorist attacks if military action in the Middle East is seen as inherently anti-Islamic. But with continuing cost-cutting and the benefits of the weaker dollar there is potential for corporate profitability to strengthen and for company results to begin to exceed analyst expectations. This might occur as early as the summer with Q2 results.
A further cause for potential optimism is tentative signs of a move towards a more generous attitude over the payment of dividends. At the moment, only some 70% of S&P Index constituents pay cash dividends, with many large, cash-rich companies, like Cisco and Intel, preferring to reward shareholders by other means, such as share buybacks. The recent proposal to end the double taxation of dividend distributions could have a profound impact on corporate behaviour. Certain high-yielding sectors, such as utilities, have attracted support. Of course, this measure, which has aroused bitter political opposition, must receive congressional approval if it is to pass into law.
But Microsoft's announcement of an initial token dividend payment creates a precedent for others to follow. Given the political risk he is taking, Bush is likely to exert considerable pressure on companies to deliver their share of the bargain and fulfil his intention of boosting share prices and thereby providing a stimulus to the economy.
The initial reaction to war was positive for equities and negative for government bonds. A continuation of this rally depends on a quick victory and no recovery in oil prices. Any complications could lead hedge funds, which are leading the way, to reverse their full positions. One thing is certain, US equities will remain highly volatile.
Partner Insight: Continuing the Architas education series for clients.
What made financial headlines over the weekend?
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