Stocks across the globe had a rocky start to the year with the S&P 500 not being the only index to give some of its 2013 gains back.
In addition, there is the potential for low growth in the US, a rise in interest rates, reduced support from the central bank and volatility in emerging markets potentially contributing to blowing US stocks off course.
Analysts have been predicting a 10 per cent correction, following negative pre-announcements of company earnings (which outnumbered positive announce-ments by 7.6 to one according to Thomson Reuters) and volatility in emerging markets in reaction to the reduction of the US bond-buying programme of quantitative easing.
The market shrugged off disappointing non-farm payrolls data on February 7, ending that week at 1,797.02, up 1.33 per cent on the day. The jobs figures also failed to curb expectations that the Federal Reserve will continue its tapering of quantitative easing, following two reductions of $10bn (£6bn) in December and January.
In spite of only 113,000 net new jobs being created in January, against expectations of 185,000, fund managers remain remarkably bullish. Richard Lewis, Fidelity’s head of US equities, says: “With no inflation in the system and zero interest rates [expected] again this year, this all argues for a continuation of high profits, low growth and probably decent equity markets. I don’t think the US equity market can do another 30 per cent, but I don’t think the markets are about to give it all back.”
Such optimism may also be attributable to a strong report on US GDP for the last quarter of 2014, showing output growth of 3.2 per cent.
Paul Quinsee, JPMorgan Asset Management’s chief investment officer for US equities, predicts modest acceleration in US profit growth and that profits are roughly in line with trend, in spite of net profit margins for S&P 500 companies of approximately 9 per cent being well above their historical average. Mr Quinsee says: “The reasons for high margins are long lasting. Multinational US corporations are major beneficiaries of globalisation and technological change and that will persist over the next decade.”
The chief investment officer says his best guess for US earnings growth in 2014 is 8 per cent, helped by continued cash backs and sweetened with faster growth in dividends, as cashflows remain strong.
Ian Heslop, manager of the Old Mutual North American fund is similarly bullish. He believes that although the forward price-to-earnings ratio – a measure of a company’s stock price against its expected earnings – on the S&P 500 is now about 15.5x, the market is not necessarily expensive.
“With economic expansion and some improvement in margins, it’s reasonable to expect earnings growth in the high single digits,” he says. “The risks are that the Fed messes up, the summer numbers are too soft or too slow, and that inflation rises.”
Jeff Morris, Standard Life Investments’ head of US equities, expects increases in merger and acquisition activity, as a result of the slow growth economy and low levels of corporate financial leverage.
Mr Morris says: “The positive reaction in the share price of some acquiring companies should serve to encourage more deals. We expect that 2014 will be more of a stockpickers market, rather than a rising tide that lifts all boats.”
Andrew Lebus, manager of the Pantheon International Participations investment trust, cites cheap energy prices as another positive factor. “They have provided a significant boost to US businesses and consumers, helping to create an attractive investment backdrop for the US industrial sector, in particular,” he says. “Signs that the US is considering the merits of exporting shale gas may also have a beneficial impact on the economy.”
Mr Lebus also thinks the US could benefit from the financial and social reforms in China, which continue to shift its economy from an export-led model to one oriented towards domestic consumption.
But risks remain, not least from internal politics, as another round of debt ceiling negotiations could rattle the markets.
The US shutdown in October 2013 took an estimated $24bn out of the economy, or 0.6 per cent from GDP growth in the final quarter. Mr Lebus warns: “The impact on economic activity may have been marginal, given the acceleration in the underlying economic growth in the US, but the impact on sentiment was significant. The message is that the US system faces crisis every time an important economic or political decision must be taken.”
Another risk is that interest rates might rise earlier than expected. With the unemployment rate having fallen to 6.6 per cent, only just above the Fed’s 6.5 per cent threshold for considering a rise in interest rates, all eyes will be on new Fed chairwoman, Janet Yellen, to see whether she gives any reassurance to the markets that interest rates will stay at close to zero this year.
The greatest fear is that if a correction occurs, it may not stop at 10 per cent. Investors today are far more funded by leverage than in the 1990s and might be forced to sell by a 10 per cent fall.
Fidelity’s Mr Lewis dismisses the likelihood of a big sell-off.
“To get a 30 per cent fall, there would have to be a big deflation scare or a huge accident in corporate earnings, such as we had in 2001-2, when the whole TMT fantasy was blown out of the water, or 2008-09 when the whole securitised credit financial innovation blew up,” he says.
“Is there such hubris in current earnings estimates that we could face a 30-40 per cent drop in the market? Apart from some exuberance in some of the social media stocks, I don’t think so.”
Pam Atherton is a freelance journalist
