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Market View: US fundamentals still look healthy

Macroeconomic concerns about the US continue to obscure the fundamental opportunities for the investor.

Are the bears’ concerns significant or are there sustainable opportunities for active fund managers in the US marketplace?

High on the list of concerns is the high level of consumer spending, which has manifested itself in a reduction in personal savings rates from 12 per cent in the early 1980s to near zero today. In reality, increases in net wealth in real estate and other areas have offset decreases in savings, maintaining overall wealth levels.

By adjusting this view of savings, current levels app- ear within historical norms, even before accounting for the effects of inflation.

The twin deficits are another concern that continues to loom large – the federal budget balance is closing in on its 1984 low as a percentage of GDP and the current account balance has reached unprecedented levels at over 5 per cent of GDP.

Here we are more cauti- ous and the growing deficits should be noted with concern. But why has this moment been judged to be the cataclysmic juncture? The trajectories of the budget and current account deficits are nothing new, as current imbalances have evolved over the last couple of decades. Clear guidance from policymakers and measured interest rate increases should provide stability for US equities in 2005. This should provide a further boost to the sterling/dollar exchange rate – a positive performance enhancement for the sterling investor in the US.

At a corporate level, the experience remains bifurcated. On the one hand, the focus on cost-cutting and controlled capital expenditure has boosted corporate operating margins to levels unseen in the last four years. However, real earnings growth is losing momentum, and labour costs continue to show an upward trend. In this environment, some companies will feel pressure on margins. This is more pronounced in some sectors than others, for example, the semiconductor sector.

Fundamentals continue to shape our portfolio construction process, not the macroeconomic environment. We favour high quality, low volatility stocks. We are focused towards companies which are capable of growing margins and are demonstrating strong levels of cashflow. A clear focus towards returning value to the shareholder, either in the form of increased dividends, share buybacks or value-enhancing acquisitions, is also attractive.

In the current environment, we find most of these characteristics in the utilities, telecommunications and healthcare sectors.

In this environment, it is important for investors to be highly selective, even within individual sectors.

For example, within healthcare, we have identified that the new healthcare legislation could place pricing pressure on pharmaceutical companies which have high product expos- ure to the geriatric market. Instead, pharmaceutical benefit managers and managed care providers should be poised to benefit.

As always, the financial market outlook is uncertain. What we do know is that equity valuations and prices seem to be aligned and that the noted concerns are well anticipated by market participants. We appear to stand neither at the gaping maw of an equity market precipice nor at the tantalising onset of another year of 20 per cent-plus returns.

Rather, with a normal yet healthy dose of uncertainty, we are probably on the verge of upper single-digit equity returns for the near future.

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