To find out how close, we must look at a few sectors. Financials, rightly, was a popular underweight in 2007 but stock prices have been marked down to a level where it is now tempting to re-evaluate the sector. Financial companies’ valuations contain plenty of bad news, and with the Fed in emergency rate-cutting mode, and yield curves responding by moving steeper, the fundamental backdrop is improving at the margin.
Is there more bad news to come? Almost certainly, with further write-downs likely in the coming weeks. Can prices go lower still? Definitely. But there is possibly good news in the offing – for example, we hear sporadic talk of an imminent government rescue package for the monoline insurers. This would elicit a rapid rally in share prices, suggesting the risk of remaining significantly underweight has increased. Certainly, the volume of bad news already absorbed and the universally gloomy outlooks being published have led us to close our previous underweight in financials.
A similar story exists in healthcare, where analysts are downbeat, citing patent expiries, pipeline problems and poor management as reasons to avoid big pharmaceutical stocks. While we would not disagree with these problems, the companies generate non-cyclical earnings growth at a time when this will be a scarce commodity in the market. Moreover, with overcapacity remaining a feature of the sector, consolidation is a possibility. Is it time to take another look at pharmaceuticals?
We have not changed our view of technology, which we do not like for its own sake (and there are areas, such as semiconductor manufacturers, where we are downright negative) but at the stock level we continue to find several companies benefiting from positive product cycles, diverse client bases and low exposure to the domestic US economy. Some of the more highly rated names have suffered multiple compression in the recent risk-averse weeks, but we remain confident they will deliver growth in the coming quarters.
Yet while we are at a crossroads of sorts, the signposts are not giving clear directions. But it is knowing when to make changes in strategy – that we know are necessary at some point in the next few months – that will be the biggest determinant of performance this year.
Cormac Weldon, head of US equities, Threadneedle.
