Share prices in the US have staged a remarkable recovery since September, and the rebound has sparked fresh hopes for a return to a bull run.
But while some say the economy is recovering sooner than expected, others predict the country has some time to wait until the economic downturn really is history.
The technology-heavy NASDAQ index has surged to nearly 2050 – up 44% from its low of 21 September, says Rupert Della Porta, head of North American equities at Aberdeen Asset Management. And the markets have further to rise. Della Porta points out that there is a huge pool of liquidity that could potentially be moved back into shares. Some $2.1trn is held in money market funds – this amounts to 21% of the value of the broadest measure of the US stock market.
Since the US Federal Reserve has cut interest rates 11 times this year, returns are now very low on cash investments. “How long do people want to keep money in deposits?” asks Della Porta.
But others are less optimistic about an early market recovery. Richard Bernstein, US strategist at Merrill Lynch, says his securities house is relatively cautious on the US stock market for the next six months or so.
“The valuations in the market right now, especially those of lower quality issues, suggest that the market has discounted the next three recoveries,” he says. “We believe the best opportunities in the US today are in higher quality assets, almost regardless of sector.”
Tom McManus, chief investment strategist at Bank of America in New York, is similarly wary. “We’re in the more defensive camp with regard to the recent rally,” he says. There is no confirmation from the economy that it is actually picking up steam.
He dismisses the positive view taking hold in New York, saying it is based on a circular argument. “The argument is that we should use the rally from the September lows as evidence that the economy has bottomed. Then we should use our confidence… as a reason to pay high multiples for stocks,” he says.
But Bank of America analysts disagree with the premise that the rally – which has brought share prices back from the lows seen in the aftermath of 11 September – is really significant.
The reason stocks sunk to their extreme lows following the terrorist attacks on the US was the atmosphere of fear and disappointment, says McManus, rather than fundamental economic weakness.
He even suggests that stock prices are now higher than they would be had the attacks not taken place. “If we hadn’t had the attacks, stocks would be lower than they are today. The legislature would not be considering a fiscal stimulus plan,” he says. McManus says his bank’s outlook for the US market remains cautious, with current stock valuations seen as high.
Market perceptions of what the Federal Reserve will do to interest rates over the next 12 months have changed dramatically. Eurodollar futures indicate the market is factoring in an increase in the Fed funds rate of as much as 175 basis points in the next year.
“I would dispute that the cumulative tightening would be as much as that,” says McManus.
Della Porta, however, says there are reasons to be positive. The burden on US consumers has lightened considerably. Energy prices and taxes are lower, cars are offered on interest-free credit deals and retailers are discounting prices, he says.
News on corporate earnings has been getting slowly worse over the past few months, but he says the market may now have seen the bottom of earnings forecast downgrades. From the middle of next year, he predicts, there will be a visible recovery.
“Because the news has been so dire, the market has got used to companies commenting on profits mid-quarter,” says Della Porta. The aim has been to soften the blow when the quarterly results are announced.
But there are now signs that US companies are giving up this practice, with John Chambers, CEO of Cisco Systems saying there is no need for these additional ‘reports’. Market participants have taken this as meaning the downtrend in earnings forecasts is at an end.
Now that the market is showing signs of picking up, strategists predict mutual funds will aim to boost their returns as quickly as possible by targeting volatile stocks that are likely to show rapid growth rather than defensive shares. Sectors likely to benefit from this tactic are software and semi-conductor companies.
Bond market analyst Ifty Islam at Deutsche Bank doubts that the fall in bond prices is really justified. “It is just the flipside of what’s happening in equities and a result of the perceived asset allocation shift to equities,” he says. “We think the market may have got ahead of itself.”
“The sell-off in fixed income is overdone… We’d be looking to buy from here,” he says.
Deutsche Bank’s analysts forecast the Fed will cut interest rates by a further 25 basis points. After that, they are expected to keep money rates on hold for the next six to eight months.
Islam says any pick-up in economic growth in the US will be associated with low inflation. The wave of price discounting seen by retailers is almost unprecedented, he says, and this may lead to a situation similar to the one in Japan, with consumers expecting prices to be discounted.