JPMorgan's 2005 forecast:
[This is the first bit of a 213-page report. Sorry can't post it all here :-) ]
Investment Conclusions
Our Views on Global Macro Trends
Economics — Global Growth to Top 3% Again in 2005 (Page
25)
The global economy looks to us poised for continued and solid
expansion in 2005. JPMorgan forecasts that global GDP will
advance 3.3% over the coming four quarters, similar to the gain
seen in 2004. Factors underpinning global growth include a
revitalised corporate sector—especially in the United States and
Japan, stimulative monetary policy, and a prospective decline in oil
prices. While we expect the base of global growth to remain broad,
we project significant disparities among regions, with the US and
Emerging Asia (especially China) looking to set the pace again in
2005. Further, we anticipate rapid growth in Latin America and
Eastern Europe. We expect Japan’s economic growth to bounce
back to a 2-3% level after a recent soft patch. We project only
moderate growth in the Euro area, where domestic demand remains
sluggish and we think exports will be hampered by the strong
currency.
Equity Strategy — We Maintain a Positive Outlook on Global
Equities (Page 29)
Global corporate profitability and strength of balance sheets and
cash flow have laid the foundations for sustainable growth. As
illustrated by the breakdown of US capex growth in 3Q04, the US
corporate sector has moved to investing for expansion, rather than
just for efficiency gain. This is represented by higher industrial
equipment and transportation capex growth, now at 10% and 19%,
respectively, while the IT capex growth rate is down to 10% from
15% previously, in line with the end of corporate restructuring. We
think solid top-line growth and stable margins at high levels should
drive earnings growth over the next two quarters above consensus
expectations. Margins should be maintained as corporates remain
focussed on containing compensation costs in line with the sum of
efficiency gains and improved output prices. We expect the oil price
to moderate, to below US$40 for WTI by 2Q04, driven by a
reduction in speculative positions and moderating demand as we
forecast global IP growth to slow to 3.3% in 2005 from 3.9% in
2004. The relief in the oil price should improve real income growth
for consumers and reduce input costs for corporates. After the
policy-induced slowing in growth in China to 2.6% in 2Q04, the
economy rebounded to 8% in 3Q, a level that we believe will be
maintained through 2005. We believe that the PBOC will raise
interest rates by a further 100bp over the next six months as it
moves towards a more market-based approach of containing excess
investment in certain sectors. We expect China to move towards a
more flexible exchange rate regime in 2005.
Sectors and Regions to Overweight — Japan, Industrials,
Healthcare
Sectors and Regions to Underweight — UK, Financials, Energy
Top Picks — Illinois Tool Works, Amgen, Honda Motor
Stocks to Avoid — Lloyds TSB, Repsol, US Celullar
Bond Markets — Reflation Remains on Track (Page 35)
A year ago, we advised to position for higher bond yields, flatter
curves and moderately tighter credit spreads. This advice was based
on our views of global reflation, solid global economic recovery,
Fed rate hikes and higher inflation. Over the past year, we find that
inflation has indeed risen, the global economy expanded at an above
trend pace and the Fed raised rates broadly as expected, at a pace of
25bp per meeting. The US yield curve flattened as we expected, but
yields rose mainly at the short end. Longer yields rose by much less
or fell slightly from their levels at the start of the year. Importantly,
bonds did not underperform cash, and a short duration strategy,
thus, did not work.
Early this year we called for moderately tighter corporate credit
spreads, but spreads have actually tightened more than we expected.
Spread compression and credit curve flattening has intensified over
the last few weeks as low yields, low volatility and healthy
corporate fundamentals have significantly increased the demand for
spread products. US corporate debt supply, on the other hand, has
been relatively modest this year especially in high grade. In high
yield, supply has been larger this year, but a great deal of that has
been used to refinance existing debt obligations, thus reducing the
likelihood of default in the near term. The high-yield default rate fell
to its historical low of 1% this past year. In 2005, we do see a rise to
about 2%, which is still well below average. These favourable
supply and demand conditions look to us likely to be also in place
next year as well, supporting corporate debt prices.
Foreign Exchange — Yet Another Year of US$ Weakness
Appears Likely in 2005 (Page 37)
US balance of payments dynamics suggest to us the US$ will
remain on the defensive into 2005. Until US growth and interest
rates are perceived by investors as attractive enough vis-à-vis other
countries to attract significantly more capital, we do not think the
US$ will be able to sustain any rallies. We do not see such a
scenario emerging until at least the second half of 2005. Even then,
our view assumes some trends that are not without risk: oil prices
falling notably lower after the winter heating season ends (late
1Q/early 2Q), US growth subsequently reaccelerating and leading
the Fed to raise policy rates to 4.25% by year-end, with investors
applauding the economy, rather than doubting growth as was the
case for much of 2004.
Even more than 2004, we believe policymakers are more likely to
act to smooth, rather than stop FX trends. As long as the US$ fall is
gradual, we believe US officials will quietly ignore the "strong
US$” mantra. However, we think ECB officials are more likely to
react to the strong € by pushing back the timing of any needed rate
hikes, rather than intervening in FX markets directly. In Asia, our
expectation for a modest, gradual, yuan revaluation should reduce
the need by other Asian central banks to fight to keep their
currencies extra-competitive versus the US$; returning inflation
pressures in parts of the region should also make large-scale
intervention much less likely in 2005.
Our Views on the Consumer Sectors
Autos — Asian OEMs Retain Best Fundamentals; Raw
Materials & FX Cloud 2005 Outlook (Page 41)
Combined auto sales in the major markets of the US, Europe and
Japan (approximately 75% of global volume) look to us likely to be
roughly flat next year. We consider three macro factors of specific
concern for global auto stocks in 2005: US$ weakness, higher
interest rates, and a step-change rise in raw materials costs. If the
lesson of the 1980s/1990s was that Asian market share gains in the
US can prove remarkably sustainable, we think the lesson of this
decade may be that they can repeat a similar feat in the arguably
tougher-to-penetrate European market. Unlike many of our peers,
we do not forecast a material decline in US light vehicle volumes
(+1% in 2005). While volumes appear high in absolute terms, US
vehicle expenditures remain in line with the 30-year average relative
to both GDP and disposable income.
Top Picks — Autoliv, BMW, Fiat, Toyota Motor, Honda Motor
Stocks to Avoid — General Motors, Volkswagen
Consumer Staples—Shop Carefully in 2005 (Page 47)
Although we expect the relative performance of FMCG stocks to
improve in 2005, we would like to maintain a generally cautious
outlook, based on challenging fundamentals and lack of compelling
valuation stories. With global FMCG stocks trading at the peak of
the 10-year 2005 P/E range relative to market, we see only selective
names offering superior earnings growth at attractive prices. Within
large caps, we expect investors to gravitate to companies that are
willing and able to aggressively return cash to shareholders and
avoid high priced ‘strategic’ deals that exceed cost of capital. We
are most cautious on global food and tobacco stocks and expect
consensus earnings estimates to continue to be revised down in the
food and tobacco sectors. Food stocks appear under pressure due to
a loss of pricing power, higher energy and commodity prices, and
health concerns hitting key product categories. Tobacco stocks are
suffering from a deterioration in European fundamentals and a stepup
in regulatory pressure. Regionally, although valuations continue
to look more attractive in Europe, we see US stocks outperforming
in 2005, due to higher earnings growth, continued FX translation
benefits, management willingness and capability to invest for
growth and company specific factors.
Top Picks — SABMiller, PepsiCo Inc, Gillette, Danone
Stocks to Avoid — Altadis, Cadbury, Biersdorf
Lodging and Leisure — The Recovery Continues (Page 53)
In our view, continued improvement in corporate demand coupled
with minimal supply growth should result in better-than-expected
results for most lodging names under our coverage through the
balance of 2004 and 1H05. The pricing outlook looks to us strong
for both the gaming and lodging sectors as we think demand should
remain above supply growth. A solid quick-service consumer, less
competitive discounting, and new product innovation/marketing
should enable companies to continue to post solid comps in 2005,
albeit below the above-average results for 2004, as most companies
face difficult comparisons and are currently constrained by higher
fuel costs. Longer term, we expect casual dining sector trends to
remain intact given the long-term fundamentals of ageing
consumers and permanently changing lifestyles, matched with solid
comp trends, pricing power, and modest supply growth. We
continue to believe gaming companies with exposure to Las Vegas
will outperform given continued strength in demand trends to this
market, and remain cautious on companies with significant exposure
to Atlantic City, which we think will likely become increasingly
competitive as feeder markets add gaming venues.
Top Picks — WMS Industries, MGM Mirage, Host Marriott
Corporation, Wendy's International Inc.
Stocks to Avoid — Aztar Gaming Corporation, Krispy Kreme
Doughnuts Inc.
Media — The Shift to Non-Traditional Advertising Will
Accelerate in 2005 (Page 59)
We expect direct marketing to head into a protracted upcycle in the
US during 2005 as clients have to look to cheaper, higher ROI
alternative media, based on eroding traditional media audiences set
against ongoing price inflation. We believe US media companies are
in the early stages of shifting their focus away from large-scale
M&A activity towards share repurchases and dividends. We view
this positively as this should augment EPS growth and drive ROIC.
The principal new theme that we expect to emerge in European
Media in 2005 is the conflict between advertising and promotions
expenditure as publicly quoted companies are under increasing
pressure to meet earnings targets. While valuations warrant caution,
we remain positive on the Asia Pacific (ex-Japan) media sector as
we believe its leverage to improvement in the domestic economy far
exceeds that of the retail space.
Top Picks — McGraw-Hill Cos, Time Warner, VNU, BEC World
Public Co, Fuji TV
Stocks to Avoid — Valassis, Pixar, TF1, Wolters Kluwer
Retail — Focus on Fundamentals (Page 65)
We have a Neutral weighting on the sector, driven primarily by
concerns over the sluggish pace of job recovery and high oil prices,
which continue to present risks for the consumer spending outlook.
We expect the premium-orientated retailers and brands will continue
to outperform the overall industry over the next six months,
particularly during the upcoming holiday season. We believe
deflation will persist as a long-term industry issue, but as in 2004,
we do not expect material price deflation at the consumer level in
the first half of 2005. We believe prices will hold relatively steady
next year, as many input costs have risen and the consumer market
has stabilised. Even in apparel, where costs will begin to decline due
to quota elimination, we expect that, initially, product quality will
be enhanced and retailers will hold prices, with some modest margin
benefits looking possible. Valuations are trading around historical
averages across most of the retail sub-sectors, on our estimates.
Therefore, we see little opportunity for broad-based multiple
expansion across the sector, particularly as we think the Fed seems
poised for further interest rate increases. Given a relatively mature
retail sector, many of our top picks highlight our focus on companyspecific
margin expansion stories. Conversely, our least favourite
stocks in part result from our view that margins are at or near peak
levels.
Top Picks — LVMH Moet Hennessy Louis Vuitton, Marui Co.
Ltd., Dollar General Corp., Polo Ralph Lauren Corp.
Stocks to Avoid —Best Buy Co. Inc., Borders Group Inc., Casino
Guichard-Perrachon et Cie. S.A.
Our Views on the Financial Sectors
Banking —A Focus on the Periphery (Page 73)
We believe developed banks should post a deceleration in earnings
growth in 2005, driven by a lacklustre borrowing picture, a
flattening yield curve (US) and sustained low rates (Europe). Cashrich
companies, still-tenuous commercial confidence, over-indebted
consumers and stable domestic demand look to us to be driving a
fairly modest loan growth picture for 2005, despite higher capital
spending (US). This trend appears to be fostering greater
competition, leading to spread erosion. Commercial delinquencies
appear to have troughed–driving cyclically low provisioning levels.
We expect a flattening yield curve to drive margin pressure in the
US over 2005, while near-term gain from a short-lived steepening
looks likely to us to be eroded in part by costly asset/liability repositioning.
A negligible rate hike outlook in the Euro-zone is
equally discouraging, in our view, as net interest margins remain
squeezed. In our opinion, Japan offers offer a compelling NPL
work-out story (as does Germany in the European context).
Top Picks — Standard Chartered, Deutsche Bank, National
Bank of Greece, Banco Itau
Stocks to Avoid — Lloyds, Credit Agricole, National Australia
Bank, Banco Popular, Washington Mutual
Insurance — Struggle for Growth Continues (Page 79)
The struggle for growth in mature markets and the steady creep of
increased regulation are the key drivers of the insurance sector in
2005, in our view. We expect that the market will pay a premium
for any insurer with a demonstrable strategy for profitable growth
against the background of a tough bond market environment and
increasing regulatory scrutiny of margins and capital requirements.
In the absence of top-line growth, we think restructuring and cost
cutting will be the key drivers of EPS improvement and stock price
performance. However, we would avoid paying a substantial
premium for longer-term growth, as we think low barriers to entry
and excess capital chasing growth opportunities will reduce
margins. Further, we expect dividend yield will be an important
differentiating factor, with the market rewarding stocks with
sustainable dividends in excess of the 10-year bond yield, and where
capital is being returned as a part of active cycle management.
Top Picks — Allianz, Everest Re, China Life
Stocks to Avoid — Aegon, Marsh McLennan, Prudential
Property — We Continue to Recommend Overweight Europe
and Underweight US (Page 83)
Continued net inflows into real estate as an asset class is currently a
global trend and, in our opinion, here to stay given modest global
economic growth, and low bond yields. In Europe, we recommend
switching out of the UK into Continental European stocks. This is
due to higher dividend yields, and less risk of a disappointment from
potential delays to the introduction of UK REITs and any significant
decline in retail sales/consumption. In the US, we are positive on
select office markets and the apartment business and believe that
office and apartment stocks should perform better in anticipation of
a fundamental improvement. In Australia, the outlook for the
underlying direct property markets looks positive to us as retail sales
remain buoyant, and office markets are finally seeing signs of
improving demand after three years of poor absorption. However,
we are negative on the Tokyo office market as we believe that rents
for the top-end buildings are likely to remain low because of the
landlords’ strategy of seeking 100% pre-lets prior to completion,
together with a significant increase in forecast supply in 2007.
Top Picks — Slough Estates, Capitaland, Japan Retail Fund
Investment, Archstone-Smith
Stocks to Avoid — AIMCO, City Development, Mitsubishi Estate
Our Views on the Healthcare Sectors
Biotechnology — Mid and Small Caps in Favour for 2005: A
Stockpicker’s Market (Page 91)
In 2005, we think the mid-and small-cap biotechnology stocks are
likely to capture the attention of most healthcare investors as we
expect many potential product approvals and pipeline developments
outside the large-cap biotechnology space. Concerns related to new
Medicare payment methodologies as well as slowing growth look
likely to us to affect the large-cap biotechs early in 2005. Biogen
Idec’s launch of Tysabri into the multiple sclerosis market may
prove to be one of the most important product launches for the
biotechnology sector in 2005. Other issues that we believe will
continue to garner attention in 2005 include continued growth on
new products such as Gilead's Truvada, Genentech’s Avastin, and
ImClone’s Erbitux.
Top Picks — Amgen, Biogen Idec, Celgene
Stocks to Avoid — Chiron, NPS Pharmaceuticals
Healthcare Services — Improving Job Market Could Bring Life
to Healthcare Service Sectors (Page 97)
We believe hospital fundamentals are nearing a turning point
associated with an improving labour market and corresponding
relaxation of pressure on hospital A/R collection rates. More
specifically, we view recent improvements in underlying cash flow
growth as a sign that the nascent stabilisation/moderation in bad
debt ratios is likely to become more pronounced over time. We
remain positive on the managed care sector as we enter 2005. In our
view, premium increases in the 9.0-9.5% range should cover
moderating medical cost trends in the same range. We continue to
be positive on the prospects for PBMs and are cautious on
distributors.
Top Picks — Triad Hospitals, Anthem, Psychiatric Solutions
Inc., Caremark Rx
Stocks to Avoid — First Health, Priority Healthcare
Medical Technology and Hospital Supplies — Fundamentals
Remain Strong (Page 103)
The Medical Products space has continued to provide outsized stock
price gains compared to the broader market. This outperformance,
however, has come with a high degree of volatility. News flow on the
various drug-coated stent programmes, for example, has caused sharp
movements in interventional cardiology stocks. The good news is that
fundamentals look strong. Sector revenue growth remains upwards of
12%, with currency contributing around 400bp in the first half of the
year. Underlying this robust growth are strong demographic trends,
new indications for device therapies opening up additional treatment
populations, mix shifts toward more value-added technology, and a
positive pricing environment.
Top Picks — St. Jude Medical, Kinetic Concepts
Stock to Avoid — Novoste
Pharmaceuticals — Deteriorating Fundamentals Despite Near-
Term Strong Growth (Page 107)
Bush’s election victory is unlikely to stop the deterioration in the
US drug business environment, in our view. Lack of pipeline, the
impending 2006-08 US generic cycle and a more competitive
managed care sector will likely ensure that pricing deteriorates even
in the absence of direct government-led price intervention. We
estimate European pharma earnings to grow 11% in 2004-09,
around twice the growth rate of their US counterparts. While the
stocks are far less exposed to the impending 2006-08 US generic
cycle, the lack of pipeline front-loads the long-term growth rate. The
European sector trades at 16.5x in 2005E, but if adjusted for US
GAAP, the multiple would rise to 17.2x. This implies a premium of
22% versus the IBES consensus estimate for the US sector.
However, given our view that risks to US pharma earnings remain
on the downside, we believe this premium is sustainable.
Stock to Overweight — Roche
Stock to Avoid — GlaxoSmithKline
Our Views on the Industrial Sectors
Aerospace and Defense — Stockpickers’ Game (Page 113)
US defense spending growth is slowing. President Bush's FY05
Future Years Defense Plan calls for a 5% investment account
CAGR through 2009. We believe budgets may slightly disappoint
over the next two years, but our longer-term outlook is more robust.
We expect outlay growth to slow from 14% in 2004 to 7% in 2005
and 5% in 2006. Defence budgets outside the US provide a mixed
picture. Despite some large recent contracts, European governments
outside the UK still have not shown a commitment to increase
defence budgets. However, the outlook for orders from Asia still
looks strong to us, and the high price of oil is helping Middle
Eastern customers.The recovery in global airline traffic should drive
after-market performance. Global RPKs through September grew
14% over 2003. However, compared to 2000, total RPK growth has
only been 2.4%. We expect deliveries of large commercial aircraft
to grow modestly, reaching 770 by 2007 from 586 in 2003.
Top Picks — Embraer, Lockheed Martin, Northrop Grumman,
United Technologies
Stocks to Avoid — Boeing, Goodrich, Rockwell Collins
Diversified Industrials and Machinery — Manufacturing
Fundamentals Remain Strong (Page 119)
Global industry looks to us poised for solid performance for the next
few years. Global IP growth estimates for the third quarter have
been trimmed by our strategists to 2.5%, but the belief is that this
deceleration should be brief. Production gains of 5-6% are projected
for the fourth quarter as the Chinese economy continues to recover
and US consumption increases. Moreover, low inventory levels
suggest to us that production should increase with a pick-up in
demand. For 1H05, we continue to believe that current guidance is
generally too conservative. Fundamentals remain strong across most
end-markets and the trend looks to us likely to continue into the first
half of next year. We continue to favour high-quality industrial
names. In the Machinery space, stocks no longer appear to be
reacting positively to incremental good news, which could suggest
that an economic recovery is largely priced into most machinery
names. Continued weakness of the US$ against the major currencies
should continue to favour US companies versus global competitors
Top Picks — Illinois Tool Works, Siemens, Atlas Copco, Tyco,
Komatsu, Fanuc
Stocks to Avoid — SPX, Milacron, Invensys, Electrolux
Transportation — Beyond the Zenith (Page 127)
Perhaps the US$64,000 question for the transportation sector is
whether freight rates will sustain their strength seen in 2004 through
all of 2005. We think this will depend heavily on trade volumes
(which are subject to the direction of the US$), and capacity
increases. Any deterioration in freight rates would benefit logistic
operators, as logistics stocks should have scope for margin
expansion, after suffering large squeezes over 2003 and 2004 on the
back of high freight rates. Tourism has bounced back and looks set
for healthy growth. The global airline industry faces multiple
challenges, although we think 2005 could see further deregulation in
aviation, providing considerable opportunity for growth. Logistics
stocks offer a lot of opportunity in 2005, in our view. As the key
intermediaries in the current explosive global trade environment, it
would appear to us a reasonable assumption that these companies
are going to seek some restoration of those margins that have been
under severe pressure in 2003 and 2004 due to a sharp rise in
shipping rates. The counterbalance here is that any success of
logistic companies would likely come at the cost of shipping lines.
We remain cautious on this sector as high growth and profits are
fully discounted.
Top Picks — United Parcel Service, easyJet, Deutsche Post
Stocks to Avoid — Evergreen Marine, JetBlue Airways,
Arkansas Best |
