LONDON, 28 April 2003 — Although the coalition forces gained a rapid victory in the war with Iraq and victims were fewer than feared, the response from the equity markets was relatively weak. The S&P500 has risen 10 percent since the low registered on March 11. But the S&P500’s index level is still lower than in mid-January. At the same time, yields on 10-year government bonds have increased by about 40 basis points. But just like the equity index, bond yields were higher in mid-January too. In other words, although the war with Iraq was relatively successful, the current market prices reflect less optimism than at the beginning of the year. Shouldn’t we expect a clearer recovery of the stock markets? Is it possible to detect the financial market trend of the next months from the latest economic releases?
Before the war with Iraq, the economic sentiment indicators obtained from consumer and business surveys fell to new lows. For example, the consumer confidence figure calculated by the Conference Board suggests that private consumption in the US will not grow any further in the next months. Also the Purchasing Manager Index calculated by the Institute for Supply Management fell strongly and now suggests GDP growth of about 2 percent. However, it must be taken into account that all these economic sentiment indicators refer to March, and in March there was still no indication whatsoever of the war with Iraq being over so quickly.
Due to this special situation the March economic sentiment indicators clearly don’t provide an accurate picture of future economic trends. The real economic indicators registered by the various statistics offices are also likely to give us a distorted picture at the moment. The latest figures concern March (or even only February). The war with Iraq most probably distorted not only the sentiment of businesses and private households, but also their spending attitude, as many expenditures are likely to have been postponed because of the geopolitical uncertainty. Only very few economic data collected in April have been published so far.
An important economic datum concerning the month of April is the consumer sentiment figure calculated by the University of Michigan. This figure recovered between March and April and indicates a respectable growth in private consumption of about 2.5 percent. We expect all economic indicators to brighten up considerably in the next months. Should this not be the case we would have to make a downward revision of our economic forecasts. So the economic data to be published in the next weeks are of crucial importance.
Alongside the economic data, the publication of corporate results also provides information on future earnings prospects. In the United States, 123 of the 500 S&P companies have published earnings figures for the first quarter. Of these, 89 companies (72 percent) posted higher earnings in the first quarter of 2003 than in the first quarter of 2002 and 32 companies (26 percent) had to report a reduction in earnings compared to the previous year. Applied to the S&P, this gives us a rise in earnings per share of about 9 percent. Furthermore, the earnings announcements of 73 companies (59 percent) were above the consensus expectations of the analysts surveyed by IBES. Only 14 percent of the cases (17 companies) failed to meet the earnings expectations.
Projected onto the S&P500 index the earnings posted in the first quarter are still altogether 3 percent higher than expected. But this basically positive earnings news did not support the market either. Instead, the results were interpreted as having been achieved by means of cost savings rather than rising sales figures. The remaining companies, which will be publishing their first quarter data in the next weeks, are unlikely to present rising sales figures, since the geopolitical uncertainty in connection with the war with Iraq will certainly have had an impact on the companies’ turnover in the first quarter.
Normally the financial markets anticipate the economic trends of the next months. So if at the end of the war with Iraq an economic upswing is highly likely, shouldn’t the stock markets already be at the beginning of a boom? This time the majority of investors, who determine equity prices, may react differently though. Why? After the bursting of the technology bubble investor confidence was shaken by a series of nasty surprises. These included Sept. 11, fraudulent bankruptcies, creative accounting, management scandals and, finally, the war with Iraq.
After all these disappointments in the stock markets investors not only want to rely on future earnings expectations but also want to see the earnings figures first. Although the hopes of an economic recovery are fully justified it will probably
still take a long time for corporate results to improve. Therefore we believe it is still too early to bank on an improved corporate earnings outlook and raise the equities percentage. We will at least wait and see if the economic indicators really do improve widely in the next months. Furthermore, at least some companies’ managements must make positive forecasts for their companies. As you know, some companies even refuse to provide guidance at all at the moment.
We maintain our neutral stance regarding equities and bonds, but will consider overweighting equities as soon as we receive improved macro-economic and corporate news. The valuation of the equity market seems attractive. For example, the P/E ratio of 15.5 of the MSCI world index is below the historic average since 1988. And the risk premium of the S&P500 is clearly above its 17-year average. Regarding bonds, we continue to aim at a shorter duration than the benchmark index. This protects us quite well from the risk of a further rise in yields. Our equity strategy remains unchanged compared to the previous months. We continue to favor energy, health care and IT.
(The information contained herein is for information only and should not be construed as an offer or a solicitation to purchase, subscribe, sell or redeem any investments. While Clariden Bank uses reasonable efforts to obtain information from sources, which it believes to be reliable, Clariden Bank makes no representation or warranty as to the accuracy, reliability or completeness of the information)
