US equities: there is a silver lining
14 February 2009It’s hard to find an economic pundit these days who believes 2009 will usher in any sort of economic recovery; the consensus is 2010 and some even believe it could be 2011 before there is a sustained recovery in the developed economies.
Just how far economists have retreated from their optimistic forecasts was highlighted by the recent Access Economics report that painted a very dire picture for the Australian economy.
Until recently, Access’s mantra had been that the Chinese and Indian economies would insulate Australia from the worst of the downturn. But no longer; its latest report notes that 10,000 Chinese factories have closed in recent weeks and staff retrenched. Although China and India are likely to avoid recession, their growth rates will slip as a consequence of limited credit and developed countries having a diminished appetite for their exports.
These pessimistic scenarios particularly apply to the US, the world’s largest economy. Despite the euphoria around the election of President Obama Barack and the proposed fiscal stimulus of $US800 billion, no economist doubts the depth and breadth of the US recession.
That said, there’s a strong possibility that US equities, as measured by the SP500 index, will outperform other share markets in 2009, particularly in the developed world. If this seems a contrarian view, there are solid arguments that can be mounted to support this hypothesis.
Amid all the gloom and doom in the US, it’s worth remembering a few facts. The US was the first country to go into recession, prompting Washington to respond with large monetary and fiscal stimulus policies. These policies could eventually lead to a weaker US dollar that will also help stimulate the US economy.
The US companies that dominate the Dow Jones Industrial and S&P500 indexes are global players with global brands. Although they will be affected by the downturn in the US economy, as well as other developed and developing economies, they will benefit from the diversification of their operations and quality of cash flow, particularly in developing countries which many economists predict will remain in positive growth territory. They will also be beneficiaries of fiscal stimulus policies outside the US in countries such as China, Japan and Germany, the three countries with the largest (non commodity-based) current account surpluses.
US dollar weakness also will boost the earnings of these companies, helping underpin their share prices as investors search for stocks that can demonstrate the capacity to at least maintain earnings in distressed times.
In effect, making a call on these companies isn’t a call on the US economy, much in the same way BHP Billiton is a call on global commodity prices, not the Australian economy.
A constant theme in 2009 will be the scarcity of credit, as well as its cost. Markets will judge companies on their capacity to either roll over debt or access fresh facilities. Arguably, debt could overshadow earnings in determining a share price this year.
In this volatile environment, banks (which could still require further capital injections) will retreat to the relative safety of their major customers; the large cap stocks, the companies that comprise the Dow Jones Industrial and S&P500 indexes. It will be their cousins, the mid and small caps, which will find refinancing debt a relatively more difficult task.
Finally, the US offers stocks in sectors that simply aren’t available in Australia, most notably defence companies. The US is already at war on two fronts and a prolonged global recession will inevitably heighten international tensions, as the 1930s graphically illustrated.
Other sectors shouldn’t be ignored, such as high-tech companies. These companies have been managing in deflationary environment for years as they have coped with lower prices for software and hardware and also the relatively recession-proof sectors like healthcare, utilities and consumer staples.
Today, many investors are shying away from the US stock market as the news and reports of a recession in the US dominate the news and investment analysis. Some are beginning to suggest over-weight US equities, relative to other developed and developing equity markets. Perhaps it’s a leap of faith, but there’s evidence to suggest such a leap is warranted.
