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US on route to recovery

For the objective observer, who wants to take a step back from the war drums and the cries for peace over Iraq (not to mention North Korea), what can one expect from US equities for the coming year?

Although recent events always tend to influence the supposed dispassionate analysis of strategists (just look at how many more have turned more pessimistic after three negative years in equity returns compared to after two years), it could be argued that a base is forming for recovery.

Although many fund managers would follow their stockpicking instincts and look for earnings recovery, it has become widespread to study the macroeconomic picture as a first step to deducing the probability of future market events.

After much cause for hand-wringing, certain economic signs in the US are improving. Certainly, there are signs of consumer confidence losing its steam. The growth of the trade deficit in the US may explain the recent weakness of the dollar as foreign investors begin to feel cautious about the US ability to service its debt.

There is also the feeling among certain investors that the US administration has been too generous to taxpayers and that this generosity will lead to problems further down the line, even if it feels good for the public in the short term.

However, if we look at the hard facts rather than future expectation, it is clear that certain positive trends have been overlooked. Unemployment has fallen back to 5.7 per cent at the end of January from a more worrying 6 per cent level. The housing market remains strong and actual retail spending is holding up fairly well. Finally, the absolute level of corporate spending has continued to rise from the lows of 2001 to 2002.

What about the all-important state of corporate USA? Yes, there have continued to be some spectacular losses announced by certain individual companies. The bigger picture, however, points to a more attractive price/ earnings multiple on both the Dow Jones Industrials and the S&P 500.

Just to take the p/e multiple of the S&P 500 on February 7, 2003 compared with mid-October 2002, the index level (price) is not dissimilar at both dates while the p/e is lower at the more recent date. This can only mean that earnings are rising, the price being more or less equal.

The fear of war seems to be keeping a lid on the normal course of economic interaction. One can argue that a resolution to the issue of disarming Iraq might provide a relief rally for US equities in the short term.

For those of us who remember the last Gulf War of 1990 to 1991, it now seems touchingly naive to remember the comments of numerous terrorist cells in Western Europe that would come alive the instant that Iraq was invaded. Nothing of the sort happened. The ability of Iraqi defences was also vastly exaggerated at that time.

Although the potential for surprise is always there, it is a fact that Iraq&#39s armed forces are weaker today than they were in 1991 as a result of the UN embargo imposed since the last conflict. UN backing would be preferable, as acknowledged by the US administration. Whatever the outcome, a US economic recovery may be quietly forming while investors&#39 eyes remain fixed on Iraq.


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