History could repeat itself
Despite the fact that the US market remains overvalued, equity returns for the year look set to continue on an upwards trend, according to analysts. This is mostly down to the continued cash flows into the $5trn US mutual fund industry, accompanied by falls in interest rates, and a sustained low inflationary climate. Some estimate that the stock market could even end between 5-10% up on the year, maintaining it's safe haven status", remarks Kaith Quinton, portfolio manager at Santander Global Advisors in Boston.
Looking at the market in a historical context, particularly over the past 30-40 years, an ongoing fall in interest rates has invariably led to a positive medium term outlook for the equity markets. "Rates are down almost 10% on a 52 week average," points out John Manley, equity analyst at Salomon Smith Barney in New York. "That in the last 30 years has given you a positive S&P in the next 12 months."
He adds: "There is no question that the stated bottom up numbers for the year are too high but I don't think analysts really believe them and there is a decent chance that we see the second quarter come in at 2-3%."
A 2-3% gain would be up from the 1-1.5% gain last quarter in the US and Manley anticipates that the third quarter may reap returns of 3-3.5%, which paints a pretty positive picture for the year as a whole.
Quinton agrees that while earnings are still an issue, the overvalued market is likely to have a positive effect, at least in the short term. "Valuations are extremely high but I think those factors will continue to push it up for at least the next 6 months," he says.
As far as sectors are concern-ed, Santander Global Advisors is currently overweight in consumer cyclicals which is its single biggest position, but is also overweighting the transportation sector. Manley at Salomon Smith Barney is viewing the pharmaceutical and healthcare stocks as most attractive.
On the bond side, again the US market seems to be following the patterns set years before. Joseph Carson, chief fixed income economist at Deutsche Bank in New York, cites the bond markets of 1986 and 1993 as previous examples of a path the 1998 stock market may follow. Both markets were largely liquidity driven, the former's rally being tied to a sharp fall in energy prices, and the latter to a radical change in fiscalpolicy, and both events drove the bond market upwards. In the current scenario the fall in energy prices has not been on the same magnitude, he admits, but while there has been no major change in fiscal policy, there has been a change in economic assumptions about Asia. Carson estmates that long bonds are expected to yield around 6.25% by year end, possibly reaching 7% next year.
He says: "What is interesting about these periods is that they lasted from anywhere from 9-12 months, and they were always followed by a period of fast growth, rising commodity process and the reversal in trends in interest rates. I think we are setting ourselves up for a similar situation but it may not be visible to later this year rather than mid-year." Rachel Oliver"