However, the markets have already priced in a lot of bad news, with valuations back to what they were 10-12 years ago, well below recent historical average. Profits remain the key factor that will determine the direction of the US equity market during the course of this year. A further market downturn would be driven by the falling profits, as a result of a period of slower growth, not necessarily a full-blown recession.
The markets should continue to be supported by the Fed's aggressive monetary and fiscal easing, including further reductions in interest rates, currently at 3 per cent, and the fiscal stimulus package coming into effect later this year. Further support is provided by a weak dollar which boosts exports and helps diversify sales away from domestic buyers. Large US-based multinationals should fare relatively well, as many global markets that have not had a significant exposure to the US subprime debt, such as Asia, China or Europe, do not show signs of a significant slowdown.
Consumer spending remains depressed by falling house prices, which declined last year for the first time since the Great Depression in the 1930s. The markets are pricing in a sharp increase in mortgage defaults during the course of this year. Interest rate cuts have so far had little effect on easing the credit crunch, making it difficult even for credit-worthy potential buyers to secure mortgages.
Subprime issues still weigh on equity markets. While the extent of the problems have become clearer since July 2007, it will take time for the markets to fully price in their impact as the products used to structure that debt were very complex and not that well understood. In the meantime, financials will remain under pressure, and hence the performance of the US stockmarket as a whole, of which they are the largest sector.
Against this background, we remain maximum underweight financials, as well as consumer sectors, which are being affected by the economic slowdown. In contrast, we have increased overweight in healthcare and materials and expanded our position in the information technology sector from underweight to overweight. The outlook remains uncertain for the US but serious recession should be avoided, with the markets stabilising following significant easing of both fiscal and monetary environment.
Tracey Lander, fund manager, Old Mutual Asset Managers (UK).
