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September 2011
U.S.A.
The S&P 500 has sold off around 18% from its high of the year as deteriorating macro data and European sovereign worries have reignited fears over a double dip recession. The story is by no means homogenous however, with US consumers still spending unabated, industrial production growing, and listed companies generating record profits.
There are several contradictory data points emerging. The Philly Fed, a survey of business activity and usually a reliable precursor to the broader ISM survey, fell from 43.4 to -30.7 in the space of 5 months. This is not far above the low of -41.2 in November 08 and consistent with a significant recession. However the ISM itself came in at 50.6, indicative of the economy managing to squeeze out marginal growth, and Industrial Production continues to expand.
The Michigan Consumer Confidence series fell from 77.5 to 57.8, only slightly ahead of the 55.3 seen in 2008. Personal Spending however continues to make record highs, and luxury consumer discretionary stocks have been outperforming helped by strong sales growth.
For the first time since the end of the recession we have seen real and substantial cuts to GDP forecasts, which now point to 1.6% growth in 2011 and 2.2% in 2012. Earnings estimates, usually late to the downgrade party, have wobbled but have much further to go if they are to fall in line with GDP cuts. Instead, most corporates have maintained that they have seen no weakening in end demand. There have been a number of exceptions to this however, with semiconductor companies in particular reporting weakness.
The S&P 500 now trades on 12.4x historic earnings, well below its 20.4x 20 year average. Although US consumers and corporates are showing increasing ability and willingness to spend the atmosphere is twitchy. Spending could be switched off, either in the form of less capital investment, falling retail sales or investors pulling money from equities. Fiscal drag will also remain a major issue. The market is therefore unwilling to pay a high multiple for stocks with an uncertain growth rate.
Our core scenario remains that we are in a sustained phase of low growth and will avoid recession. At times economists will extrapolate positive short-term trends to predict stronger GDP growth, and the market will go through a phase of euphoria on the premise of normalised growth returning. At other times the opposite will be true, and the market will fall on fears of recession. We are currently closer to the latter scenario, with fear pervasive in the marketplace. We however believe that the consumer is strong enough and sufficiently blind to international affairs to sustain the weak and bumpy recovery. Despite the caveat that European woes are likely to make the next few weeks volatile, the reasonable economic fundamentals and low valuation makes this an interesting entry point for the long-term investor.
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