The US economy has been encouragingly resilient to its housing sector blight and the recent turmoil....
The US economy has been encouragingly resilient to its housing sector blight and the recent turmoil. The Federal Reserve has played a deft hand in returning liquidity to the system and investors have eagerly recommitted to equities, pushing the Dow Jones Index to all-time highs in early October.
The booming US stock-market recovery since August has been met by warnings of impending bust. The market's jittery reaction to Caterpillar's recent downward revision of profits suggests volatility will stalk equities for some time.
Caterpillar aside, the latest earnings projections have been robust. Despite the financials sector, we have seen upside revisions for the whole market, with telecommunications, healthcare and industrials looking very buoyant and analysts expecting double-digit growth from technology and consumer discretionary.
Structurally, the key factor in the US' favour is its defensive economy. The scale of its healthcare and consumer staples sectors will always cushion it from a global cyclical slowdown. During the past two recessions in 1991 and 2001, these areas were beacons of outperformance.
The US also remains the world leader in technological innovation. It exports its expertise globally and earns billions of dollars from economies needing catalysts to fuel their expansion. It has a clear edge in global technology brand names, such as Apple, Google and Cisco Systems, which deliver cutting-edge product development through useful capital reinvestment and raw imagination.
US GDP is in line to grow by around 2% in 2008, which factors in a measure of deceleration in the economy in the next six months. The fundamentals are fairly supportive. Although employment needs to be monitored closely, inflation remains muted. This will give the Fed scope to cut rates further if necessary, which will be a crucial support for equities.
Overall, the market is still relatively cheap, although the benign valuation picture would be threatened by a weakening of 10-year bond yields. Benchmark yields remaining steady or falling are important for investors' perceptions of valuation and for their influence on future economic activity.
Taking a pure top-down perspective can be misleading. The US remains a target-rich environment for stockpickers. We expect 7% earnings growth in 2008 which, with a 2% dividend yield and cash being returned to shareholders, could easily add up to double-digit local currency gains.