Size of rally still surprising investors
Apr 22 2009 by Andrew Miller, The Journal
LAST week’s rise in markets (another 4-5% across most of the major indices), left the current rally for equities in its sixth consecutive week.
The size of the rally continues to surprise some investors: the MSCI World index has gained over 20% since March 9, led by the US and Asia excluding Japan, which have both seen their markets rise by more than 25% in local currency terms. The only market that has not joined the party, at least not in the fullest sense, is the UK, where the FTSE All-Share index has risen a shade over 17% over the same period.
But enough of the past; what about the future? As we have discussed in recent columns, it is still too early to talk of the start of a sustainable recovery. Even if equity markets have turned a corner, we would be wary of buying into the current rally in the very short term.
Stock markets have moved too fast on the back of economic and corporate news flow that has merely turned from being black to a dark shade of grey. In other words, “blue skies” are still some way off and there still remains a significant risk that an exogenous shock could knock the recovery off track. Indeed, a surprise from an unexpected source – an event that is “not on the radar” as far as economic policymakers are concerned – could easily stall any equity market recovery.
Furthermore, equity markets will have to digest a lot of earnings news over the next four weeks, some of which is likely to be poor.
The US earnings season seems to have got off to a good start with a number of financial stocks reporting numbers ahead of (significantly lowered) expectations. However, this week markets move into the peak period for earnings reports with some 124 companies in the S&P 500 due to release results, and our expectation here is that there could be some significant negative announcements.
As we write, analysts’ expectations are that first-quarter earnings will be 38% lower than last year, while second-quarter earnings are expected to be some 33% lower. This leaves us to expect earnings per share for the S&P 500 index to come in around the low $40s this year, and in the mid $40s next.
Following the recent sharp rise in stocks, this leaves the US market trading on a forward price-to-earnings ratio of 21 times for this year and 19 times for next year, using our estimates. Bearing in mind these somewhat lofty multiples, it is not hard to understand our caution regarding whether or not the current sharp rally in stocks can be sustained.
Given how things currently stand, we therefore prefer to recommend overweighting Asian and emerging market equities, rather than focus on the markets in the West where a lot of the good news is already priced in.
We believe that Asian and emerging markets should be at the forefront of the global recovery and the equity markets in these regions offer the greatest long-term upside as they are essentially a geared play on global equity market returns.
Finally, from a sector perspective, we still believe that for the medium term economically-sensitive “cyclical” sectors look more attractive than defensives, although in light of the recent rally, buying on any dips – as well as good stock selection within sectors – is likely to be key.
Andrew Miller is regional office head of Barclays Wealth
