After the optimism of December, when so many positive indicators were in evidence, 2005 has experien...
After the optimism of December, when so many positive indicators were in evidence, 2005 has experienced a hesitant start based on unexpected signs from the Fed on the interest rate outlook. Although uncertainty was never far below the surface for much of 2004, it is disappointing to see its revival amid indications that the out-turn for Wall Street in the current year may not be as straightforward as anticipated.
Most issues relating to US financial markets can be viewed from two sides. Today's bears can readily cite the low savings rate or the record current account deficit, as deterrents to investors, while bulls can equally dismiss these as the badges of success for a fast growing economy. There is a similar story for the continuing weakness of the dollar. While it is positive for economic growth and for company profits, limiting returns for investors based in strong currency areas deters overseas fund managers from adding to their existing underweight positions in US equities.
The recent release of minutes from the December Fed meeting, which signalled the likelihood of further interest rate rises, has already disturbed the previous consensus view that short-term interest rates might end 2005 at little more than 3% (against 2.25% today). With growth prospects (GDP up 3.5% or so) for 2005, the Fed feels confident that higher interest will not derail recovery and that the current monetary stance is too stimulative.
The Fed has raised short-term rates by 0.25% at each of its last five meetings. If it continued the sequence at each of the eight meetings scheduled for 2005, rates would stand at 4.25% by the year end. Such an outcome might also push up bond yields, potentially undermining consumer confidence and may even reverse an expected decline of the dollar.
The healthy outlook for the corporate sector could outweigh these potentially cautious economic developments. Having increased by around 20% in 2004, company profits are forecast to show a further rise close to 10% in the current year, with revenue growth and margin enhancement both playing their part.
In contrast to the position of the public sector, corporate balance sheets are in a healthy state, giving companies great flexibility in how they deploy this strength. In the absence of higher capital spending, the most likely routes are continuing share buybacks, M&A activity or more rapid dividend growth. Each quarterly reporting season, starting with the present one, will be closely watched for indications of a clear trend.
The monthly Merrill Lynch survey of fund managers suggests that US managers are more optimistic than their overseas counterparts. More to the point, private individuals, who own 40% of US shares, seem confident if stronger trends in mutual fund purchases are a reliable indicator.
By contrast, the survey proposes that some overseas fund managers' US shares are overvalued, with most holding very underweight positions. Some of this divergence can be explained by the impact of dollar weakness on different categories of investors. The relative demanding valuation of US shares (a prospective price earnings ratio of 16 and a yield of 1.9%) also gives rise to caution among overseas managers whose own markets are more modestly valued.
Canada is all too often overlooked in the rush to focus on its giant southern neighbour. Yet it offers interesting prospects as although its growth and inflation outlook closely resemble the US equivalents, the Canadian dollar is a stronger currency than the greenback. Investor interest in 2005 is again likely to centre on individual situation, especially in the oil, gas and mining sectors.
In conclusion, it is quite likely that 2005 will see only modest gains from the Dow or the S&P 500 Index, at least in European currency terms. However, the size of the US market (over 50% of the FTSE World Index) and the strong representation of global leaders in so many key sectors, provide plenty of opportunities for selective investment.
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