Having risen gently through the first two months of the year, a sudden bout of selling in late Febru...
Having risen gently through the first two months of the year, a sudden bout of selling in late February and early March drove Wall Street sharply lower.
Why did this happen? A threat that the Chinese government might take steps to cool its stock market was the initial prompt for investors to reconsider their appetite for risk. But it was negative comments about the US economy from Alan Greenspan, the former chairman of the Federal Reserve, and the difficulties reported by sub-prime lenders that were of more immediate concern to US investors.
Our view has long been that the US economy will enjoy a soft landing. While GDP growth will slow in 2007, the US economy should still grow at an acceptable rate, and may even outperform other developed economies. GDP growth this year should come in at around 2.4%.
While this represents a slowdown after a prolonged period of high growth, it still presents a strong backdrop for corporate profits. Those of a bearish disposition point to the weakening of the US housing market – house prices are struggling following a long and strong run. Confidence in the housing market ebbed quite rapidly last year: in 2006, prices recorded their first year-on-year fall in recent memory. Significant inventory of housing stock for sale suggests the correction may last longer than some people expect.
So, US housebuilders and sub-prime mortgage lenders might not be the most attractive areas in which to invest. Equally, the consumer discretionary sector may struggle for some time as rising house prices no longer offer the strong support they once did. Yet the US stock market is so diverse, and the earnings of US companies draw on such a wide variety of economic trends and forces, that a US housing market slowdown is less of an issue to the stock picker. The consumer discretionary sector is struggling, but a focused stockpicking portfolio need not be exposed to it.
Though the US market rose sharply last year, earnings growth rose more quickly, with the result the market's earnings multiple fell. The US looks cheap on a historic basis, particularly large-caps. The earnings yield on the S&P500 is above the 10-year Treasury yield – yet more support for the value case for investing in the US. Though we may not see earnings growth of the magnitude reported in the fourth quarter of last year, we believe analysts' assessments of US company earnings are overly pessimistic.