Investment Week - US
21 January 2010
Following unprecedented government intervention, the US Equity market has rebounded over 70% from lows experienced less than year ago. It has been a classic cyclical recovery as financials took early lead as the economy and capital markets pulled back from the brink. Other economically sensitive groups such as consumer discretionary, technology, basic materials and industrials then assumed responsibility for the markets upward move. With the market pricing in a better economy, the threats arise from the one side in which government support is removed too abruptly or the other side from too much stimulus being applied resulting in an overheated inflationary environment.
Government fiscal and monetary support is likely to persist for the near term as interest rate policy is expected to be accommodative until the middle of 2010. Only 30% of the $787 billion stimulus package has flowed through to the economy as of yet. The removal of stimulants such as low interest rates as well as tax incentives for first time homebuyers must be managed well. This will ensure that the economy does not fall back into the hole it just climbed from, while not providing so much of a boost that an inflationary spiral is generated.
The bleak labour market is constraining inflationary pressures. Unemployment that has breached 10% will likely remain high well into the economic recovery. Early last century, job creation in the manufacturing sector would account for roughly a third of job gains post the end of a recession but in two recent recoveries, in the 1990s and the 2000s, the manufacturing job rebound has been much more muted. Also generating caution on the jobs front is the small businesses optimism index which remains at low levels, indicating restraint from a group of employers that are typically large job generators.
The markets appear to be counting on an orderly economic and profit recovery as the forward looking price to earnings for the Standard and Poor’s 500 Index is currently 15x, inline with the average post the tech bubble. It remains to be seen if government policy actions can keep the economy on solid economic footing without a misstep that would send the market tumbling.
Bull Points
- Significant corporate underinvestment creating pent up capital spending.
- Normalisation of capital markets that permit the liquidation of distressed assets and the regeneration of lending capacity.
Bear Points
- Unemployment that remains stubbornly high.
- Removal of governmental stimulus that has been essential to the economic rebound.
Jeff Morris, Head of US Equities, Standard Life Investments
This article was first published on Investment Week online on Monday 1st February 2010.
