When will share prices in the US finally hit bottom? Faced with the endless questioning from investors, equity strategists have trawled through the data, and some have come up with reasons to be optimistic.
“Identifying turning points is clearly very difficult,” says Sam Mercer-Nairne, US fund manager as SG Asset Management. However, from a historical perspective, the market is now around its fair value rather than cheap or expensive he says. Price earnings ratios stand at about 17 currently – and this is a level that the market appears to be comfortable with, he says.
Fundamentally, the US economy appears healthy, he says, adding that the stimulus applied by interest rate and fiscal policy should be powerful enough to ensure that the economy avoids a double-dip recession.
Chris Johns, equity strategist at ABN AMRO, says the current level of the US stock market should be the bottom – according to the fundamentals. “But we know these fundamentals can be breached for quite some period of time,” he cautions.
“With war with Iraq potentially to come in the next six months, this will be a very difficult time,” he says. “The numbers tell us the market should be OK, but sentiment says otherwise.”
It is the uncertain nature of the tension with Iraq that is putting pressure on the market, say strategists. Market players are hoping either for a short military conflict or confirmation of a peaceful resolution to the situation. “If we see some confirmation there, we may see the oil price drop off a bit,” says Khuram Choudhry, equity strategist at Merrill Lynch in London.
In mid-October, sudden upticks in US stock market levels raised hopes that the bear market could finally be running out of steam.
But Mark Beale, deputy CIO of New Star Asset Management, was not convinced by the latest stock surge. “We are certainly having an oversold bounce at the moment,” he says.
Choudhry agrees. “I don’t think we can trust it; it is not the start of something new.”
Beale argues that the market can go lower than current levels. Fourth quarter corporate earnings figures are looming, and particularly in the financial sector this last quarter is usually the time when bad operational news tends to be thrown out. “I think there is bad news to come in terms of sub-prime lending and other issues,” he says.
Worries about bad debts have been gnawing away at sentiment in the banking sector, despite efforts by Federal Reserve chairman Alan Greenspan to calm them.
He told the American Bankers Association recently that the US banking system was in healthy enough to survive the corporate downturn. Better risk management and larger cushions of capital meant the banks were in a far better shape than in the aftermath of the recession in the early 1990s, he said.
Choudhry says an analysis of investor behaviour throws up some reasons to believe the market has upside potential. “It appears that institutional cash levels have picked up, and that bodes well. Having cash on the sidelines, ready to be invested, is a positive signal,” he says.
And, he points out, within options trading, the level of sells has increased. “That is generally a good contrarian indicator,” he says. Also, among company directors trading in shares of their own companies, there are now 18 buys for every sell. “That is quite a high rate by historical standards,” he says.
On the other hand, the gap between US bond and equity yields has not yet closed to the extent that it has in the UK. This means US investors still have an excellent reason to prefer bonds to shares. In the UK, the dividend yield stands at around 3.83%, compared with a 10-year bond yield of 4.5%.
“A situation is arising in the UK where equities are looking more desirable (from the yield side), but that cannot necessarily be said in the US,” says Choudhry. In the US, there is a gap of around 200 basis points between equity yields and those of 10-year treasuries, he says.
However murky the near-term directional outlook for major US equity indices is, experts agree that the market is likely to remain volatile for the next few months. “The market is very sensitive to news flow and could overreact,” says Mercer-Nairne.
Consumer staples, such as Coke and Pepsi, he says, have performed so well that they have become very expensive now. On the other hand there are areas that have done badly so far – basic industries such as chemicals and metals – where there is now room for price improvement.
“We think capital expenditure will come back, though it will be slow and muted, so we think valuations in those industries are looking very attractive,” says Mercer-Nairne. “Fundamentally, the more economically sensitive sectors are beginning to look attractive.” More controversially, he says, SG Asset Management favours the telecoms sector. All of the pieces are in place for an improvement in trading conditions within the sector, he says.
Looking ahead to 2003, Beale sees US equity prices rising during the year. “In December, people will focus on 2003.
There have been three years of down markets and next year the market will look reasonably cheap on balance,” he says.
Any recovery in the market is likely to be fairly broad-based, he adds.

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