Joanna Shatney, Head of US Large Cap Equities
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For professional investors and advisers only. This document is not suitable for retail clients.
Sequestration refers to the mandatory cuts in spending, directly impacting defence and Medicare spending (part of the Budget Control Act of August 2011). While some of these cuts are already partially reflected in analyst estimates, there are likely to be some downward revisions to GDP by Wall Street economists. We are watchful of these cuts, but remain optimistic that: growth prospects for corporate earnings will be stronger than consensus expectations, that government cuts will not translate into a significant headwind and that valuation of equities should capture investor interest.
Our base-case scenario is that sequestration comes into effect for at least several months and that headlines remain a primary worry for the remainder of the year. It is highly unlikely that Congress finds a resolution ahead of the March 1st deadline, so the question becomes when is the real deadline for resolution and there is no definitive answer. The realm of possibilities range from a grand plan (unlikely) to an annual resolution of the required cuts. Republicans are focused on entitlement reform, while Democrats are looking for a measure of increased revenues (tax increases) and marginal entitlement cuts. Budget proposals are expected early next month and will incrementally add to the debate but, in our opinion, any really impactful decision making appears unlikely.
For investors, corporate earnings should be of greater concern. While GDP will be hit by these government spending changes, we see the multiplier effects as being more limited than the tax increases agreed to at the end of calendar year 2012 – and more manageable for companies. We are hopeful that an improving economy outside of government spending, higher corporate confidence and a return to more normal international growth trends (aided by China) will lead to earnings per share growth of at least 5-7%. As the political debate continues over the next few months, bears are expecting a market pullback similar to what we experienced in 2010 and 2011. We are more confident that this becomes a consolidation rather than a dramatic pullback and we would be buyers of the dip.
Equity valuations remain compelling in the US. Bond markets are starting to show some slowdown after the hard run over the last few years. The S&P 500 is now up approximately 7% with mid-caps up closer to 9% since the beginning of the year. Bonds have shown more modest gain; high yield is up 1.6%, investment grade corporates up approximately 0.5% and treasuries down marginally. Our argument for equities has been the extreme valuations that exist in the bond markets compared to the equity market. While this equity discount has existed for the past several years, a moderate growth scenario for earnings and low valuations should pull investors into equities.
Important Information:
For professional investors and advisers only. This document is not suitable for retail clients.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Schroders has expressed its own views and opinions in this document and these may change. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.
Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA, which is authorised and regulated by the Financial Services Authority.
Source: ETFWorld – Schroders
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