09:02am EST 30-Nov-00 Goldman Sachs (Abby Joseph Cohen) No Symbols
Investment Strategy: Inflection Point Approaching
Goldman, Sachs & Co. Investment Research
Investment Strategy: Inflection Point Approaching
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* Recent data confirm that the macroeconomy has decelerated, and that *
* corporate profit growth has slowed. This has long been part of our *
* market outlook, as has the expectation that moderate growth will *
* continue in 2001. Recent company announcements are not discordant with *
* this view. Indications that cash is building in portfolios, and that *
* valuations are the most appealing they have been all year, support the *
* forecast of rising stock prices. Our 12-month price target for the S&P *
* 500 remains 1650. Our model portfolio continues to suggest a 35% *
* combined weighting in Technology and Telecom; at the close of November *
* 29, the actual combined weighting was 32%. *
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Abby Joseph Cohen, CFA (New York) 1 212-902-4095 - Investment Research
Gabrielle Napolitano, CFA (New York) 1 212-902-2019 - Investment Research
=================== NOTE 8:50 AM November 30, 2000 ====================
* The Investment Company Institute reported that cash increased by $23
billion in equity mutual funds during October; $26 billion went into
money market mutual funds. ICI reported an aggregate cash ratio of 6%
in all equity mutual funds in October; the ratio was about 6.8% if
Growth and Income funds (which can hold short-term fixed income
securities in lieu of cash) are excluded. Sector funds had a cash ratio
of 7.6%. These cash ratios are comparable to those seen in autumn 1998,
a period of notable investor caution associated with worrisome global
economic and financial conditions.
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1. EARNINGS PREANNOUNCEMENTS HAVE STARTED EARLY AND UGLY FOR THE FOURTH
QUARTER. BUT WHAT WILL THE QUARTER REALLY LOOK LIKE?
Two technology companies advised investors after the close on November 29
that their yearend-selling season is proceeding more slowly than had been
expected. The share price reaction was negative and swift.
In recent days, our technology analysts have reviewed their fundamental
expectations in specific industries within the sector. They do NOT see
evidence of particularly weak conditions. Indeed, demand appears to be
solid in several categories, including enterprise hardware and software,
and across several markets, including those in Europe and Asia.
Nevertheless, it is possible that companies, even those enjoying a strong
quarter, may remain quiet during the current period of investor disquiet.
There is a full month left in the quarter (and even more time for
retailers), and much business is yet to be done. Further, some corporate
managers may be reticent to provide information prior to actual quarterly
reports, given their uncertain transition to Regulation Fair Disclosure.
Let's keep in mind that most company preannouncements are negative (indeed
80% of those in recent years have been gloomy), and may not be indicative
of broader problems. Let's also remember that fourth quarter results are
typically the most difficult to forecast each year, regardless of economic
sector; they tend to be weaker than might otherwise be expected based on
operating conditions. Writeoffs are often concentrated in the final
quarter of each year, as many companies clear the slate for the coming new
year.
2. THE MACROECONOMY IS DECELERATING TO SLOWER, MORE SUSTAINABLE, GROWTH.
Our expectations for 2000 have long assumed that the pace of economic
growth would be cut in half during the course of the year. In the fourth
quarter of 1999, real GDP growth was 8.3% and S&P 500 operating profits
grew at more than a 20% annualized rate. The fourth quarter of 2000 is
likely to bring real GDP growth of about 3% and gains in S&P 500 operating
earnings per share of 7%. Simply stated, the macroeconomy is undergoing a
transition from the rapid growth of 1999 to a more sustainable pace that is
close to the low-inflation rate suggested by trends in labor productivity
and growth in the labor force. We believe this is good news, not bad,
because it increases the likely longevity of the economic expansion.
Even so, the transition has been confusing and worrisome to investors.
This is particularly so for those who raised their growth expectations-for
both the economy and corporate profits-during the halcyon days of the first
quarter of 2000. Our longstanding, and unchanged, operating earnings per
estimates for the S&P 500 are $56 and $60 in 2000 and 2001, respectively.
These lead us to expect a fair value price target of about 1650 during the
next 12 months.
3. VALUATIONS HAVE BECOME MORE APPEALING. OUR MODEL PORTFOLIO IS NOW
OVERWEIGHT IN TECHNOLOGY, FOR THE FIRST TIME IN A YEAR.
Our model portfolio has long suggested a combined weighting of 35% in
Technology and Communication. In early autumn 1999, this recommended
weighting exceeded the actual market weighting of 28%. By yearend 1999,
this 35% recommendation was equivalent to a market weight. By mid-March
2000, the actual weighting had risen to 45% and our (unchanged) recommended
weighting represented a notable underweight. Our model portfolio had gone
from an overweight recommendation to an underweight recommendation due to
changes in share prices. THE OPPOSITE HAS NOW OCCURRED.
THE ACTUAL COMBINED WEIGHTING HAS FALLEN TO 32%, AS OF THE MARKET CLOSE ON
NOVEMBER 29. OUR RECOMMENDED 35% WEIGHT ONCE AGAIN REFLECTS AN
OVERWEIGHTED POSTURE. Of the two component sectors, we would be overweight
in technology and slightly underweight in telecom.
4. SIGNIFICANT CASH LEVELS HAVE BUILT IN MUTUAL FUNDS AND OTHER
PORTFOLIOS. THIS, IN COMBINATION WITH ATTRACTIVE VALUATION, SETS THE STAGE
FOR HIGHER SHARE PRICES.
The Investment Company Institute released data on October mutual fund
activity after the close on November 29. The liquidity ratio for equity
funds rose to 5.99% from 5.33% in September; actual cash holdings in equity
mutual funds increased by $23 billion. This is in addition to the $26
billion flow into money market mutual funds. Recent anecdotal data from
the mutual fund industry suggest that inflows continue and that mutual fund
cash ratios have risen further.
The 6% liquidity ratio in equity mutual funds is the highest seen since
autumn 1998, a period of extreme investor caution associated with fears of
global recession and deflation. This reported cash ratio is somewhat muted
by the large asset base of Growth and Income mutual funds, which can hold
short-term fixed income securities, such as Treasury notes, and therefore
run low cash levels. Excluding Growth and Income funds, the cash ratio in
equity mutual funds was 6.76% in October. In Sector mutual funds, the cash
ratio was 7.6%.
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