With core inflation moderate in recent months, we expect continued gradual increases in short-term rates into early 2006, and a further flattening and possibly a short-term inversion of the yield curve.
Corporate earnings continue to be robust, and rising cash positions among corporations are leading to some shareholder demands for positive steps (dividend increases, share buybacks, acquisitions or other investments).
Finally, the ongoing political tensions in the US are seeping into Canada, with a no-confidence vote toppling the ruling party. The longer-term implications of the election results on Canadian fiscal policy could impact growth.
A popular game among investment professionals in the US is trying to identify the point in time at which ‘growth’ investing eclipses the long dominance of the ‘value’ style in equities markets.
First, the areas of unanimity – with some exceptions, both strategies have underweighted the financial, and consumer discretionary sectors. Financial firms, particularly banks, whose results hinge on spreads between short- and long-term interest rates, have seen opportunities diminish with the flattened yield curve. Consumers face a growing drain on their finances resulting both from increased short-term financing rates and from sharply higher energy costs as winter arrives.
We are positive on the energy sector, with a recent focus on equipment and services providers over producers, while the value team’s approach underweights the energy sector overall with the focus on producers. From the growth point of view, the production side has experienced sharp increases in revenue which are factored into share prices over the near term, while the equipment and services industry stands to benefit from increased pricing power as growing exploration and production constrain capacity. Thus, while the first phase of the cycle favoured the primary producers, the second phase may favour those who service the producers.
In contrast, price appreciation already reflected within all industries in the energy sector makes it increasingly difficult for the value team to identify individual stocks at sufficiently attractive valuation levels. In particular, as the value team focuses on measures including price to cash flow and dividend yield, they find fewer qualifying names among the producers, but virtually none among the equipment and services providers.
Scott Ayres, senior product manager, actively managed equities, Northern Trust Global Investments.
