Where the action is
Economic growth is accelerating globally, led by the excellent performance of the US economy. Conditions for sustainable growth in the US are falling into place, rising profits are positively contributing to economic growth and monetary policy is easy and fiscal policy will remain supportive ahead of the presidential election. Outside the US, particularly in Asia, recovery is dawning. Although the Euro-zone is lagging, signs of recovery are emerging.
Taking a view of each of the major market sectors, we prefer UK and Far Eastern banking stocks over US or European banks. UK bank valuations are much more attractive than US valuations, and Far Eastern banks should benefit from top line growth in lending and rising penetration of financial services.
The cyclical upturn suggests that telecoms will not outperform in the medium term. Globally, we prefer mobile phone companies to fixed line operators as the prospects for revenue and earnings growth are superior. Current and prospective merger and acquisition (M&A) situations among wireless companies may heighten interest in the sector, however.
We are expecting a recovery in corporate spending on technology this year to be led by financial services, communications, and manufacturing. Our preferred industries are software, storage, communications equipment, and processors. After strongly performing in 2003, however, prices are relatively expensive and vulnerable to disappointments.
The newly passed US Medicare bill will be positive globally for healthcare companies. In the second half of 2004, pharmaceuticals may benefit from the expected climate of rising interest rates – this usually enhances relative performance of the sector. Regionally, our preference is for US companies in both ‘pharma’ and ‘medtech’.
Last year saw many oil companies disappoint the market despite the high oil price. If the oil price remains high this is likely to be because of higher production costs and lower volume growth in oil production and it is unlikely to feed through into higher profits for the oil majors. Moreover, “reserves categorisation” uncertainty resulting from the recent Shell episode is likely to cast a shadow over the sector for the rest of year. As a result, we have a relatively cautious outlook for oil stocks in 2004.
We expect utilities to under-perform over the next 12 months. Often perceived as a proxy for bonds, utilities have little upside potential in a rising interest rate environment. There is an absence of any foreseeable positive catalyst.
Share prices for industrials and capital goods companies rallied in 2003 on optimism that the improving global economy would spark a recovery in the sector. For this out-performance to continue, investors will want to see evidence of organic growth in sales. Efficiency gains should help higher quality companies to improve margins and cash flows should remain solid.
The defensive properties of the consumer staples sector mean that it is unlikely to out perform in the recovery phase of the economic cycle. Top line growth rates are low, and companies seem unable to grow organically without making acquisitions, which can often to destroy value.
We have a relatively positive outlook for consumer discretionary stocks in 2004. Rising interest rates could put pressure on the consumer, however, and retailers have already shown their propensity to cut prices to maintain sales. Our preference is for the leisure and media industries.
We see significant upside in general insurance stocks in the medium term. As insurers have seen much more capital destroyed in recent years by stock market falls and terrorist attacks than they have raised, the scope for further growth in premium rates remains. Company valuations are also attractive.
The path of the US dollar is very important in 2004. A further significant or rapid weakening of the dollar versus the euro and Asian currencies would have a negative impact upon the global economy. One of two scenarios could result: the US economic recovery could become too hot, fuelling fears about rising inflation; or too cold, re-igniting deflation fears and dampening the earnings revival.
We maintain our overweight equity position. And we also keep our pro-cyclical bias in stock selection globally.
Tony Broccardo is chief investment officer at F&C Management in London