Market Review: The "goldilocks" US economy
May was significant in terms of market re-ratings. Tyndall Investment Management New Zealand Ltd managing director Anthony Quirk comments on the state of the markets.
Tuesday, June 1st 2004, 11:39AM
by Anthony Quirk
|
This market summary is provided by Tyndall Investment Management New Zealand Limited (Tyndall). To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Monthly Market Review here |
While the numbers make it appear to be a relatively low key month in terms of positive or negative returns, May was significant in terms of market re-ratings.
On the bond side there is now obvious anticipation of interest rate rises from the US Federal Reserve, as shown by the progressive rise in yields over the past few months.
US short term interest rates have risen from their low of 0.9% to currently be 1.1%, while 30 year bonds have gone from 4.6% to 5.3% on the same basis.
Likewise there has been considerable adjustment in the US sharemarket. While the major US equity index (the S&P 500) was essentially flat for the month, there was a significant P/E compression. The "E" component (earnings) continued to rise above expectations, while the "P" (share prices) stayed flat. This has meant, according to ABN Amro, that the average P/E, based on consensus earnings forecasts, for the S&P 500 has gone down from 18.1x to 16.0x.
A key reason for this? Fears of significant interest rate rises over the coming year.
As mentioned in last month's commentary, such (early) market adjustment is very healthy and helps mitigate the potential for a speculative "bubble" to occur, which could result in a substantial market fall later on.
The clearly signalled (and anticipated) US interest rate rises has allowed markets to (relatively) smoothly adjust interest rates. Married to this has been the fantastic earnings growth of US corporates, which has meant that stock prices have not been savaged by the spectre of interest rate rises. That is, the strong earnings performance of US corporates has definitely cushioned the effects of rising interest rates.
What to watch for from here? Unexpected inflationary shocks which could force the Federal Reserve to move much more dramatically than is currently impounded in market prices.
The source of such shocks could come from: 1) the US economy becoming white hot or 2) oil prices going through the roof.
In terms of the former there were signs through April and May of inflationary pressures in the US picking up. Part of this is the somewhat surprising return of corporate pricing power. The ability of the low cost producers from Asia to import cheaper goods into the US had taken much of the pricing power away from US corporates. However, the very strong economic recovery has provided a "window" for price increases, which many US companies have grabbed.
This is probably not a permanent return to "cost plus" pricing and is more likely a cyclical than a structural shift. However, it does partly explain the current strong earnings growth profile in the US – the other contributors being excellent productivity growth and strong consumer demand.
From here the US economy is not likely to over heat. There are enough signs of easing consumer confidence and retail sales to suggest that the "goldilocks" (not too hot or too cold) economy may continue. Also, oil prices are certainly starting to impact on the US consumer with pump prices rising significantly in the US.
The US economy will not be able to sustain its strong economic recovery if oil prices increase materially from here. On the surface rising oil prices are inflationary. However, if dramatic enough, they may cause the Fed to re-think its tightening timetable to ensure that a repeat of the oil crisis (and global recession) of the early 1970s does not occur.
While there has been a recent oil price rise through imbalances in demand and supply the fact remains that, even at US$40 a barrel, oil prices are well below historic levels, if inflation adjusted. For example, according to Credit Suisse First Boston, even at US$41 a barrel, the real price of oil is 19% below the 1990 spike after Iraq's invasion of Kuwait and 55% below the record real level reached in 1980.
The global economy should be able to adjust and cope with oil at current prices and as mentioned above, this could actually help to slow down the currently buoyant global economy. However, large price spikes can induce recessions. Thus, the recent terrorist activity in Saudi Arabia is a real concern.
I must end with a brief comment on the recent New Zealand budget. I have no issues with the desirability of helping very needy families and the fiscal surpluses are sufficiently large to allow this. However, I am disappointed with the lack of drive in the budget to lift New Zealand's economy, which is the only way that every New Zealander's standard of living can rise in a sustainable manner.
As it is for any company to succeed, part of this must be to try to make New Zealand "different" in the eyes of international investors. Thus I find the statement that we should be happy that, after making suitable adjustments, our tax rates are comparable to Australia, distressing. Surely we should trying to make ourselves more competitive than our nearest neighbour and other countries as well?
The clear risk is we continue to demand a first world lifestyle as we slip down the economic league tables in terms of our wealth per person. The goal of lifting New Zealand into the top half of the OECD has been shelved it would seem.
Comment on the month's numbers.
In terms of the market numbers for May the best performing equity market was the NASDAQ, which was up 3.5%. The New Zealand equity market paused for breath, weighed down by a plethora of new companies listing on the stockmarket. The NZSX50 Index was down 1.3% for the month. On the bond side, the domestic market had a roller coaster ride with long-term yields finishing roughly where they had started the month.
To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Anthony Quirk is the managing director of Tyndall Investment Management New Zealand Limited (Tyndall) Anthony Quirk is the managing director of Guardian Trust Funds Management. Special Offers
« Banking on houses Are we in the twilight zone of tax breaks on AUTs? » Commenting is closed
Printable version
Email to a friend
