FYI | Jun 26 2008
By Chris Shaw
Seven interest rate cuts and more than $100 billion in tax rebates are clear stimuli for the US economy, but in the view of Standard & Poor’s Investment Policy Committee they will be at least partially offset by the impact of rising food and energy costs on consumer spending and so the group has a neutral outlook on US equities at present.
The other headwind for equities in the group’s view is how quickly the US Federal Reserve reverses course and starts to push interest rates higher to deal with the threat of inflation, all of which is expected to combine to make the earnings outlook more subdued than the Committe had expected earlier in the year.
It is now forecasting an increase in operating earnings for the year for the S&P500 of around 8%, down from its forecast of a 16% increase as of the beginning of January. This will to some extent mask what should be good performance from most companies, as the group expects nine of the market’s 10 sectors will post earnings growth and only the financials will record lower earnings. This sector of the market is tipped to record an earnings decline of 24%, while earnings expectations for the energy and consumer staples sectors have been revised higher since the beginning of the year.
One possible sweet spot for the US market in the group’s view is the midcap sector, where it sees some reason for optimism as investors can generate better returns from the sector in the early stages of any upswing as the companies are more nimble than their larger counterparts, while at the same time still offering many of the defensive qualities of the large cap companies.
As well, the group notes the strongly performing utilities and IT sectors make up about 8% of the Midcap index against only 4% of the broader S&P, so relative performance should be better from the midcap end of the market. This is particularly the case as midcap earnings growth is tipped to come in at around double the rate of earnings growth for companies in the S&P500 Index.
There is less value in the small cap end as the group’s analysts are predicting only 9% earnings growth for companies in the S&P SmallCap 600 Index, while valuations look a little more stretched at around 19 times earnings in the current year against 15 times for the broader market.
Within all sectors of the market the group’s analysts see stronger earnings performance from the growth end of the market rather than value plays as for S&P500 companies the split is 13% for growth stocks against 2% for the value stocks, while midcaps again show a pronounced split between the 23% earnings growth expected for growth stocks against 7% for value plays.
At present the group considers the energy, health care and IT sectors as the major growth sectors of the market, followed closely by consumer staples. In contrast the value end is represented by financials, telecoms and utilities. In terms of asset allocation the group sugggests being overweight the IT and materials sectors given the inflationary outlook and the value on offer, while going underweight health care given less defensive appeal and utilities on valuation grounds.
