Thread, LB's recent take on US Investment strategy...
Headline: U.S. Investment Strategy: EPS Exceeding Expectations
Author: Jeffrey M. Applegate
Company:
Country: MKT CUS
Industry: NOINDU
Today's Date: 04/20/98
* With almost one-third of S&P 500 companies reporting, positive EPS surprises
are outpacing negatives by slightly better than a 2:1 ratio.
* U.S. stocks have already achieved more than half our expected return for
this year, so the market could be ready for a breather, or maybe a correction.
* Japan continues to not get it, and if Tokyo cannot implement effective
policy change to reverse or even slow its course, rest-of-world equities could
well replay last year's Asia video clips and go down.
* We have no plans to attempt to raise cash and market time that correction,
if it occurs.
* Our Fed Policy Indicator says the Fed's on hold for now but our economists'
forecast suggests a Fed ease during the second half of 1998.
EPS Exceeding expectations
First-quarter EPS reports are exceeding expectations: positive surprises are
outpacing negatives by 2:1. That said, U.S. stocks have already achieved more
than half of our 31% expected return for the year. And it's only April. So
something earnings disappointments later in the year, Japan worries, or
whatever should provoke U.S. equities into a breather, and maybe a
correction. But if a modest correction is as bad as it gets, we'd opt to stay
fully invested.
First-quarter S&P 500 earnings are coming in better than expected: with almost
one-third of the companies reporting, positive EPS surprises are outpacing
negatives by slightly better than a 2:1 ratio. About 54% of the reports are
positive, 24% are negative, and the balance neutral. Because analysts had
slashed first-quarter EPS forecasts, we thought we could be setting up for
positive surprises (see EPS Whipsaw Ahead?," U.S. Strategy, March 23, 1998).
That appears to be happening.
That said, U.S. stocks have achieved more than half our expected return this
year. And it's only April. So the market should take a breather, at least,
and maybe correct. Candidates for a correction abound. Stocks are quite
pricey on every measure of interest rate valuation, potentially prompting some
equity-battering asset allocation trades. Saddam appears to be attempting an
exit from his box again. Kenneth Starr and Paula Jones promise to keep the
President under some pressure. Most worrisome, Tokyo continues to not get it.
The leading lights (sic) in Japan aver that they're different from the rest of
Asia because they have a pile of savings. True. But hardly the point. So
rising Japanese joblessness and bankruptcies, alongside a lower Nikkei and
yen, are in prospect (see Joe Rooney's Japanese Proposals Insufficient,
Global Strategy, April 13, 1998).
If botched policy in Japan is indeed the major risk to global equities, the
dialectic seems the same: lower Japanese financial asset prices force grudging
policy change (January); lower asset prices force policy again (April); lower
asset prices force change again (July?). As Japan continues to marginalize
itself, rest-of-world equities could well replay last year's Asia video clips
and go down. Should that occur, we've no plans to attempt to raise cash and
market time. Last year, U.S. equities had two 10% corrections; we stayed
fully invested, which worked out okay. We plan to stay fully invested now as
well, given our expected equity return of 31% for 1998 and our view that
Japan will ultimately do enough to avoid complete meltdown.
Meanwhile, deterioration of U.S. net exports as a result of the Asian
recession remains the major reason why we think U.S. GDP will slow. Bit by
bit, that slowdown appears to be under way. As that occurs, domestic capacity
utilization should roll over further, as it did modestly this week. We will
closely watch companies' response to this slowdown because it has sizable
implications for profits. The last time capacity eased during this business
cycle was 1995. Unusually, profit margins didn't because companies cut labor costs with alacrity as demand slowed. We're forecasting the same dynamic this
year. So far in 1998, we've got three months of falling manufacturing
capacity utilization. And managements are responding: among the companies
that have announced labor force reductions in response to slowing demand in
the past two weeks are Ameritech, Intel, Xerox, Corning, United Technologies,
and Converse. As U.S. net exports deteriorate further this summer, we expect
companies to shed hours worked and workers. Moreover, some of the recent
financial industry M&A will lead to redundancies. Despite slowing demand, we
do not expect profit margins to reverse as they have during prior business
cycles.
This process also has implications for monetary policy. In 1995, the final
Federal Reserve hike in the funds rate was in February. That spring,
managements aggressively cut hours worked and workers; the monthly job numbers
became negative, to nearly everyone's surprise. By July, the Fed was easing,
a mere five months after the final tightening. In the spring of 1998, signs
of slowing GDP are coming into place. The last employment number was
negative, to nearly everyone's surprise. We expect a modestly rising
unemployment rate alongside 1% inflation and GDP below 2% to prompt Fed
ease during the second half of 1998.
In that regard, we have a new March value for our Fed Policy Indicator, -1.
That's the same value we had for February. On our FPI, a value in excess of
+10 for at least two months signals that the Fed will tighten. A value below
-14 for at least two months signals ease. Thus, our FPI says the Fed's on
hold for now. Fundamentally, that remains our view, too. For now. Assuming
our economist forecast unfolds, the first Fed ease probably won't happen until
the Federal Open Market Committee meeting on August 18. |
