FYI | May 31 2006
By Greg Peel
Merrill Lynch Investment Managers in the US are not convinced inflation pressures are the reason the US market is correcting. Chief Investment Officer Bob Doll suggests that if inflation were truly the culprit, the energy, industrials and materials sectors should have outperformed during the correction, as these sectors benefit from higher inflation.
The opposite has occurred – in fact these sectors have been amongst the worst performing. Hence Doll believes there is another factor at play, and that is a slowdown in economic activity from above-trend to below-trend growth.
The dominant theme facing equity markets, says Doll, is one of moderating economic growth. He sees a weakness in consumer spending fuelled by record energy prices, rising borrowing costs and a slowing housing market.
This view has been confirmed to some extent by last night’s falls in New York where Wal-Mart announced slowing sales and triggered fears of falling consumer sentiment. (Doll provided his views prior to last night). Not that a spooked market needs much to tip it over at present. A higher oil price also added to ongoing inflation fears, with all eyes still fixed firmly on the Fed’s response.
Again, all sectors fell across the board without discrimination, echoing Doll’s thoughts that inflation is not the single culprit, but slowing economic growth may well be. The US economy grew at 5.3% in the first quarter, but Doll believes this will represent a "high water mark" for the year.
It will take some time for the markets to digest a developing economic slowdown, says Doll, and thus equity prices may yet be under pressure for weeks, if not months. The most vulnerable asset classes are those that have run the hardest – commodities, emerging market equities and small-cap stocks.
However, the good news is that over the longer term Doll remains positive. He believes the risks of resurging inflation are low and he does not expect a hard economic landing for the US. Fundamentals remain intact and valuations and earnings should support the market going forward.
It is all a correction within a bull market, Doll offers.