Stocks are rocked by double hit

Jan 27 2010 By Andrew Miller, The Journal

STOCKS were hit by a double whammy last week - namely fears that China's monetary tightening will slow global growth and concerns relating to President Obama’s proposed reforms of the US financial sector.

Arguably, neither development should have come as a major surprise. A more material tightening in China has been on the cards for some time, including (in our view) some eventual exchange rate appreciation. And further financial re-regulation in the US has been a fairly safe bet since the dark days of the crisis – and, at the moment at least, it looks as if politicians are being startled into action now by the rebound in Wall Street’s profitability.

For our part, we are currently underweight in both emerging Asian markets and financials in an equity-only investment portfolio.

We are, however, unconvinced that the recent setback marks the long-awaited significant setback to the ongoing rally in equities and risk assets in general.

Towards the end of last year we suggested that investors should add more non-cyclical (and non-financial) stocks to their portfolios, but this was not intended as a defensive move, simply part of what we termed a mid cycle strategy – that is, recognising that the most dramatic phase of the equity market recovery was over, meaning that the sectors that had performed very well were unlikely to keep rising at such a heady rate.

By contrast, sectors that have lagged the strong equity market to date – such as consumer staples, pharmaceuticals, and telecoms – now appear attractive in our view.

Context is also important here, however. Stocks were "out of the blocks" very quickly in 2010, and our end-year S&P target of 1,225 was already looming a little too close for comfort. The faster pace of monetary tightening in China is partly a result of even stronger-than-expected growth there.

At some stage tighter credit will bite more painfully, and when it does the hidden inefficiencies of the Chinese growth model should surface. At such a point, Chinese demand is likely to falter, and commodities will surely suffer too, given China’s global importance as a consumer of raw materials. But this is not something we think investors should worry about just yet. And, in our view, the setback is likely to be cyclical, rather than secular: the structural (should that be political?) imperatives to China’s long-term economic growth seem likely to be in place for many years yet.

It is perhaps more difficult to dismiss the potential impact of more US financial regulation, should last week’s proposals eventually make it into legislation: after all, financials still account for roughly a fifth of the global equity market. And the outlook for both hedge fund and private equity business models could take a further knock, as sponsorship there from the financial sector is significant.

But for now we note that in the non-financial bloc, the current US results season is coming in ahead of expectations – both for net income and revenue – and we still think it likely that when the current season ends, analysts will again nudge their full-year 2010 forecasts higher.

Andrew Miller is regional office head of Barclays Wealth in Newcastle