There is no doubt that, as far as the corporate sector is concerned, things are looking up. The repo...
There is no doubt that, as far as the corporate sector is concerned, things are looking up. The reporting season is in full swing and, thus far, the majority of companies have reached their earnings forecasts via the combined effects of severe cost cutting and debt repayment or restructuring on the bottom line. The bull investor nirvana of top-line growth, however, remains maddeningly elusive.
From March until May this year, equity markets rallied due to the perception of under-valuation and as investors' appetite for risk increased. The second stage of the market recovery saw macroeconomic indicators start to improve and corporate profits respond positively as investors looked ahead to a fully-fledged economic recovery. Now just past the half-year stage, it appears as though the risks for the equity market are on the upside, at least until year-end. Over the next few months, liquidity and the implicit promise of central banks not to raise interest rates for the foreseeable future could lead equity markets higher. The single digit returns that most market observers, including myself, expect to see in the second half of this year could be easily eclipsed.
Overall, my view is polarising between cautious optimism for the remainder of 2003 and unadulterated caution thereafter. It is expected that the FTSE 100 Index could reach 4,300 by year-end. This is primarily based around a view of the US economy where there are initial signs of investment spending returning and, consequently, the possibility of economic growth exceeding 4% in the final two quarters of 2003. Indeed, such an outcome will be required in order to justify the valuations of the cyclical sectors that have been leading the market for some months now. Thereafter, much depends on the earnings outlook and we will see whether the impact of volume growth on company earnings will be as pronounced as most commentators expect, with extra sales having a geared impact on a cost-shorn profit and loss account.
Beyond 2003 the caution is, in part, based upon a view expounded by our in-house economists who expect economic growth to be lower than the consensus in 2004. Their view is that economic activity is being pulled forward by the impact of extremely low short rates, fiscal incentives and mortgage refinancing in the US. There is some sympathy with this view. Certainly were the rout experienced in long bond markets over the past six weeks on the mere sniff of a brighter economic picture and the removal of the 'unconventional policy' promise by Greenspan to be maintained, then the US consumer story would look much less healthy into next year.
Alan Greenspan's successor will certainly have their work cut out. In the past thirty months, the US economy has benefited from 5.5% of interest rate cuts and fiscal stimulus totalling nearly 5% of GDP. More is in the offing, already passed through congress. Simultaneously, a lack of domestically-generated savings or excess consumption forces the US to import excess foreign savings via running ever wider current account deficits. With debt to GDP within the US household sector now through 80%, and the government's net liabilities approaching 50% of GDP, these problems are just being stored up for later. With the authorities so set on reflationary policies, these problems only intensify and, it could be argued, help contribute to the successive bubbles we have witnessed over the past four years in equities, property, mortgage refis, credit and now long-term bonds. It is these concerns that prohibit me from subscribing to the 'it's the start of a new bull market' view espoused by some market commentators.
Despite this medium-term caution, for the time being, it appears as though the path of least resistance for equity markets is higher. The combined effects of economic improvement, liquidity and a turning earnings cycle ensure this. At an overall index level, improvements are more modest. This reflects the relatively defensive nature of the top 20 stocks within the UK market, which still account for over half of the market capitalisation of the domestic market. The out performance of mid and small-caps is likely to remain intact for the remainder of the year. However, fantastic intrinsic value has now disappeared and we are into the realms of momentum and traditional earnings cycles. While non-economic sensitives lack an obvious catalyst for a re-rating, they now offer tremendous value. In fact, a complete reversal of the situation five months ago.
To promote 'long-term investment'
Switching 'hard and expensive'
Smaller funds still packing a punch
To drive progress