Equity markets in North America have been heavily influenced by concerns over the three 'Is' - infla...
Equity markets in North America have been heavily influenced by concerns over the three 'Is' - inflation, interest rates and international events, with the Middle East in particular capturing attention in the latter category as investors fret over the high oil price. However, although all three are significant, their impact on market sentiment appears to have been excessive.
Inflation, for example, is becoming an issue and worries over its emergence have added to uncertainty among investors. But it is not necessarily negative for equities. More companies, particularly among household commodities and services, as well as some basic industries, have taken measures to improve or retain their profit margins by passing on higher costs to their customers. With consumer spending in the US and Canada still strong and some early evidence of wage inflation appearing, some companies are now able to start raising prices. This will help them to offset the increases their suppliers have been levying over recent months on the cost of their packaging and their plastic components, as well as fuel and utility charges.
Although some recent data has been weaker than anticipated, the economic backdrop is generally showing signs of picking up and allowed companies to pass some cost increases onto their customers. In the US, this is particularly evident among the food producers and for commodity-driven household products such as coffee, toilet paper and detergents. WalMart has already signalled that it will be raising prices over the next few months by warning its customers that inflation will rise in the second half of the year.
From an investor's point of view, this should be good for stock prices in these sectors enjoying pricing power. In Canada, the materials, metals, and chemical stocks have faced a mix of pressures. The chemical sector has faced higher energy costs, amplified by the depreciation of the Canadian dollar in the first four months of the year. Pulp and paper stocks are seeing some benefits from higher newsprint prices, although the outlook for newspaper advertising in North America remains muted.
There has been little resistance from consumers to the initial moves to raise prices, and they are clearly not yet feeling the pinch. US consumer spending has remained strong, with annual growth in retail sales in the early summer the highest since early 2000, while underlying spending in Canada has been steady since spring 2003. It is clear that with higher fuel and food prices, the consumer will not be the engine of growth going forward.
Profits growth has remained strong and although some slowdown in the rate of growth is anticipated, as the best of the productivity surge has already been seen, US profits growth should continue to exceed consensus expectations into 2005. In terms of sectors, basic materials profits have been particularly strong. The only sector that has struggled has been communications, due largely to fierce competition in telecoms which was reflected in poor results from AT&T in the US. Canadian telecom firms have also faced pressures due to a price war with and between cable companies.
Meanwhile, companies have been benefiting from the efforts they made in recent years to tidy up their balance sheets and are now generating higher levels of profitability and free cashflow, which they have been employing in a variety of ways. Some have increased dividends while others have announced stock buybacks and the level of merger and acquisition activity is picking up. Cashflow is gradually strengthening across the market, but the areas which are delivering consistently strong growth are healthcare, technology and defensive sectors such as consumer staples. Several large companies have unveiled plans to return cash to shareholders, the most notable being Microsoft, which announced a range of special dividends and buybacks that will lead to the company paying out around $75bn over the next four years.
There was a big surge in mergers and acquisitions towards the end of 2003, particularly in the US banking sector. This has slowed over the past few months, but with companies holding considerable levels of cash, there are rumours across a range of sectors. In Canada, there has been a particularly high level of M&A activity in the oil and gas sector, with 42 transactions in the first half of the year including, for example, British Gas purchasing the Canadian assets of El Paso.
Canadian companies are likely to deliver higher earnings growth than those in the US, but should prosper in an environment of benign interest rates. We expect the early signs of pricing power and continued strong profits growth to broaden out to other areas of the market.
Two global vehicles
'Further plug advice gap'
Must appoint separate CEOs and boards
Advisers do come out well
Will report to Mark Till