A US soft landing
US fund managers have raised their expectations for GDP
growth for 2000 and 2001. While 83% now expect Fed Funds to
rise over the coming year, they expect a soft landing free from an
upturn in inflation after just two more 25 bps rate hikes. We are
skeptical. In his Humphrey-Hawkins testimony, Alan Greenspan
said that he had been around long enough “to never take an oil
price shock unseriously”. He could have gone further in our view
and said that no central banker, himself included (1987–90),
had ever delivered a soft landing during one. Unless the oil
price falls and stays down, it still feels right to overweight cash.
European optimism is very high
A stronger than expected upturn in non-US growth could
drive the oil price higher. Europe could be one source of upside
growth surprises. Economic optimism is very high. Fund managers
assume that the ECB is hiking rates to offset the inflationary
impact of a weak euro, but they are not targeting below-trend
growth. Importantly, 77% of European fund managers think hiking
rates specifically “to defend the euro” would be a bad idea.
We agree. Such a policy could put the economic upturn at risk
by starting a vicious circle where equity capital leaves Europe,
the euro weakens further and rates are hiked again.
Getting bullish in the UK
Only 67% of UK fund managers expect base rates to be
higher in a year’s time. With inflation expectations modest, bears
of Gilts outnumber bulls by just 5% as against 37% in January.
Earnings expectations have stabilized and fund managers see
value in the market. Bulls of UK equities outnumber bears by
a strong 44%. Support for financials has risen, 41% now
choose it as their favorite broad sector. Financial stocks would
be major beneficiaries of a soft landing.
TMT: Looking for a way out
The TMT phenomenon
Global Tech, Media and Telecom stocks have outperformed the
broad equity market by a massive 180% since 1990. Relative
performance has been especially strong since the interest rate
cuts of 1998. These sectors now make up almost 40% of world
stock market capitalization. A large sector outperforming like
this demands attention. Most fund managers choose Tech,
Media or Telecoms as their favorite global sector.
How to value TMT stocks?
It can be a struggle to value these new companies. Many, especially
fledgling e-commerce businesses with high advertising
and capital spending needs, are not forecast to make a profit for
the foreseeable future. Traditional measures, such as dividend
yield or price-earnings ratio, mean nothing for such companies.
Most fund managers use PEG or EV/EBITDA to value TMT
stocks. These methods are deemed appropriate for fast-growing
profitable companies. For loss-making companies with high
scalability, fund managers prefer EV/Sales.
Overvalued and overweighted
Regardless of which method is being used, fund managers
in every region are unanimous in deciding that TMT stocks are
overvalued. However, the vast majority of these are overweight
TMT stocks. European and Asia-Pacific funds are
particularly overweight.
Looking for a way out
While Asian fund managers are generally happy with their
overweight positions, most fund managers in the US and
Europe expect to reduce their exposure to TMT stocks over the
coming year.
But what would be the trigger to make them sell TMT? In general,
managers are looking at company- or industry-level information.
A total of 57% expect some kind of sell signal from company
fundamentals, technical analysis or sell-side broker
recommendations. Only 15% think macroeconomics is relevant.
Macro factors suggest caution
Fund managers are looking for company-specific developments
to decide when to sell. But TMT stocks did not rise on a company-
by-company basis. They rose en masse. We think macroeconomic
factors will drive the reversal when it comes. Our suspicion
is that the rush into cyclical growth stocks like TMT was driven
by hopes of permanently strong growth with low inflation. The
growth stocks doing well are not the defensive ones, like consumer
products, but the aggressive cyclical ones, like technology.
The interpretation must be that the markets do not see rising
commodity prices as something that can cause inflation. In terms
of the “Investment Clock” diagram we use for our asset allocation,
the markets are assuming that we will always be in Phase II.
A new era or the Japan effect?
We are not convinced that such a new era is upon us. We prefer
to look for more mundane reasons for the strong growth and
low inflation in the US. Alan Greenspan took advantage of the
disinflationary impact of the decade-long slump in Japan by
allowing America to grow more strongly. Inflation fell as it often
does when growth is strong and competition is fierce. However,
non-US recovery could reduce America’s speed limit. As the Fed
slows growth, productivity could worsen, causing companies to
raise prices in response to rising unit costs. Rising inflationary
pressures should drive a move into value stocks. If global growth
peaks, on the other hand, cyclical earnings expectations are likely
to fall and we would find ourselves in Phase I or Phase IV.
Will Greenspan backtrack on the new era?
Alan Greenspan must target the US stock market to cut off the
equity wealth effect that is boosting consumer spending. So far
his rate hikes are having the desired effect on the Dow, but his
frequent affirmation that we are entering a new era seems to be
driving the Nasdaq higher. A strong Nasdaq could partially
counteract the dampening impact of interest rate hikes. This has
an interesting consequence. The more Greenspan verbally backs
the new era, the more he may have to raise interest rates. He risks
having to use a sledgehammer to crack a nut.
