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The outlook for US equities in 2004 continues to improve.
This comes in spite of the fact that interest rates are on the way up, and sooner rather than later. “The Fed is looking at sustainable jobs growth of between 200,000 and 250,000 a month,” says Richard Batty, global investment strategist at Standard Life Investments. “It could raise rates at its September meeting, although the market is going for a June rise. But I think we need to see more than just one month of good data before we can be sure.”
He adds: “The financial markets have been pricing in Fed funds rising to 3.5% by end of next year if the economy continues to recover, inflation starts increasing and the very strong non-farm payroll continues. We could be at 1.25 and 1.5% by end of this year. However, there is still a lot of slack in the market so the chances of entrenched inflation coming through are very small.”
But the slack in the economy is fast being taken up. “Against that backdrop the fed cannot continue with such a loose monetary policy with real rates currently negative,” says Franz Wenzel, senior investment strategist at AXA Investment Management in Paris. “Greenspan will increase rates by 25 basis points in September and within twelve months they could be at 2.25%. He adds: “It could easily be that Greenspan goes for higher rates in June.”
The feeling is that the corporate sector will take over from the consumer sector as the main driver of economic growth. “Profits advanced some 27% in Q4 2003 and are expected to grow another 16 to 20% in Q1,” says Ned Riley, director and chief investment strategist, global fundamental strategies at State Street Global Advisors, in a report published last month. “Higher personal incomes, improved confidence and continued consumer spending will generate a greater comfort within the corporate community for growth which, in turn, should free up the mountain of liquidity stashed on the sidelines.”
“The problem for the US is next year when we see a number of arguments kicking in against growth,” says Wenzel. ‘If the price of gasoline stays at the current high level, and there is a minimum threshold for Saudi Arabia of $25, this could easily drive up to 0.3% off growth.”
But Batty is sanguine: “I think there are a number of signs that growth will continue. The dollar has been weakening and there are signs that world economy is recovering on a more sustainable path than it was a couple of years ago, especially in Japan and China. The US which is the world’s central bank is adopting very aggressive reflationary policies and that has to feed into the economy.”
So which sectors are likely to do well this year? Opinions vary. “We like industrials, consumer sectors and investment banks.” Says Batty: “The banks are a play on M&A and the continued stock market recovery.”
“We have also been buying technology stocks recently,” he continues. “Technology has been a very poor performer this year so we feel that it is offering more relative value with a fuller economic recovery coming through. On the whole our strategy is pro-cyclical.”
But Wenzel of AXA takes a different view: “Sectors like technology no longer respond to favourable macroeconomic data,” he notes. “A lot of the good news is already priced in.” He adds: “Defensive sectors like health and consumer staples have not benefited from the upswing so far. So this year global asset markets may well be driven more by stable sectors like healthcare.”
In terms of the choice between small and large cap, Batty notes that “sector exposure of small cap is more cyclical because the nature of their businesses is more cyclical and we are pro cyclical just now.”
“We favour large caps for valuation grounds,” says Wenzel. “The valuation bonus of small caps was wiped out after the strong outperformance.”
Given the good performance of the US corporate sector as a whole, it looks like the only way for equities is up. Batty forecasts that “with the dividend you could get a return of 5 to 10 % quite easily. Equities will do better than treasury market.”
“We think the S&P500 could reach 1,200 by the end of this year,” says Wenzel. “But we could easily see bumpy range between 1,050 1,250 when Greenspan starts to hike rates. So the market could move sideways and end 6 to 8% higher than today’s level.”

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