Rate rises key to US market prospects
Our geographic asset allocation is being driven by both sector and economic factors. Currently, the ...
Our geographic asset allocation is being driven by both sector and economic factors.
Currently, the main sector debate is between old and new economy stocks. In our view, low inflation isn't good for the entire equity market. In fact, during the 70's and 80's consumer related companies benefited from inflation and money illusion - where consumers frequently confuse nominal and real variables.
Today low inflation is making pricing more transparent and traditional consumer product sectors are seeing margins and profits fall as they struggle to increase prices in line with CPI.
Therefore, our bias is to favour companies whose volume of business is growing profitably and whose sales growth is not dependent on increasing prices.
In recent months we have maintained an underweight position in the UK for both sector and economic reasons.
The FTSE All-Share provides few companies that offer sustainable and exciting volume growth, and a rising interest rate environment was a poor backdrop for the market as a whole.
Looking forward, the UK interest rate cycle may be near its peak. Retail sales have started to slow, consumer confidence is slipping and sterling's strength is having a dampening effect on the manufacturing sector. If upcoming statistics confirm this trend and provide the prospect of a soft landing, we will look to build up the UK weighting by increasing holdings in cyclicals such as resources, building and financials.
The key feature for equities in the US over the next six months is just how aggressively the Federal Reserve will increase interest rates. Preliminary figures indicate the economy grew by 5.4% in the first quarter of 2000. However, due to the growing trade deficit, this understates the strength of the domestic economy where consumer spending increased by some 8.3%.
Recent inflation statistics suggest this strength is unsustainable without igniting inflation.
This will prove a difficult environment for US equities. America is home to some of the best technology companies in the world and if, as we expect, technology spending in Europe and Asia mirror the last five years in the US these companies will continue to have excellent growth opportunities.
In Europe there should be enough economic capacity to absorb accelerating growth with little threat of inflation. The outlook for profits is improving and we are finding attractive investment opportunities, particularly in telecoms equipment where the likes of Nokia and Ericsson are experiencing strong growth.
Our enthusiasm and overweight position is tempered only by the weak euro and the prospect that interest rates might have to rise further to curb the euro's slide and ease currency related inflation.
In the Far East economic news continues to improve. In Japan the March Tankan showed the fifth consecutive quarterly improvement in manufacturing sentiment, and capital spending - driven by technology investment - is strong.
Company valuations, however, are still high, particularly in our favoured new economy areas. Asian markets, on the other hand, provide a broader spectrum of attractive companies - hence our above benchmark weighting.
Yields on long bonds in the US and UK are low in response to shrinking supply. These technical reasons are likely to remain in place for some time. Fixed interest in Japan provides little value.
Euro bonds offer more attractive yields and a cheap currency, and real yields of 3.9% on US Tips offer excellent value. In general we aim to continue our underweight position with a bias to Europe and Tips.
Anthony Tait is director of institutional clients, Baillie Gifford
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