The outlook for US equities for the coming year is positive. According to Darrell Riley, vice president of T Rowe Price in Baltimore, “the consensus is that S&P index will increase by between 5 and 10% by the end of the year.” He adds: “what is priced into the market now is that the recent fiscal and monetary stimulus that has enabled the market to turn will fade. Spending and hiring will weaken to some degree and the economy will go into decline in the second half. The Fed will start to increase rates mid year, inflation will increase slightly, and the dollar will show a modest decline.”
However, Riley’s own prognosis is much more upbeat: “I believe that the economy will accelerate beyond expectations. Furthermore, the Fed will adopt a very accommodating monetary policy and will not raise rates at all. Global growth will be stronger than most anticipate and there will be a very gradual decline in the dollar. The fiscal stimulus that was put in place last year will continue to filter through; it includes accelerated depreciation allowances for businesses to encourage them to buy capital equipment. We will then have hiring related to that, so inflation will pick up.”
Gert Biesmans of the equity research team for global markets at Fortis Bank shares the optimism: “in 2003 we saw consumer spending pick up again; until now, most of the rally was due to this. Now we are expecting to see progress in corporate investment which will further drive stocks. We are seeing the first signs of this at companies like Cisco.” But he adds a note of caution: “we are positive about the outlook for US stocks although we think US markets are more expensive in valuation terms than European ones. We are looking for a more optimistic outlook from the companies – that is a key issue now.”
Rolf Elgeti, head of equity strategy at Commerzbank’s London office says that “there has been a big turnaround in both the US and global economy which for many sectors has led to top line sales growth for the first time since 1999.” But Elgeti also feels the need for caution: “the current expectations for earnings this year are too bullish. The earnings expectations of 15-16% for this year are too high and companies may only grow their earnings by only 9%. The market may need a reality check before it can continue to rise, and a correction might happen in five months or so with the first quarter’s earnings figures.”
Elgeti explains his caution: “We have all sorts of rising costs – raw materials labour costs transport, packaging costs energy. But overcapacity and an excess of competition means that these costs cannot be passed on. So companies do not have any real pricing power, which means that inflation, and therefore rates, will stay low for the short term. Companies’ lack of pricing power may limit the rise in the Dow to between 10% and 12% by the end of this year.”
Overcapacity is also an issue for Riley, but he explains the positive implications for interest rates: “the Fed will not do anything with rates until they see more meaningful inflation, say above 2%. This is a real break from the past when the Fed would have hiked rates at the first sign of growth. This is due to the ‘output gap’, which means that actual growth in the economy is lower than potential growth. Capacity utilisation remains low so unemployment is relatively high, and as a result, inflation remains within the target range. But we will see an improvement in the labour market as well as some narrowing of the output gap. There will be upward pressure on prices but not enough to be an inflation threat.”
So which sectors do we need to watch? According to Elgeti, “the sector most at risk is the chemical sector where the energy and raw materials component is particularly significant.” He believes that the sectors with more positive prospects include media and transport: “These sectors have some pricing power. Furthermore, they have the advantage of high fixed costs so any sales growth will go straight through to the bottom line.”
Biesmans of Fortis adds: “the outlook is particularly good for IT, financials, automobiles, media, consumer durables hotels, restaurants and leisure, and of these media is the most promising. In these sectors we may see growth of up to 15%.”
Companies with a market capitalisation of less than US$2bn (E1.6bn) (‘small caps’) have been outperforming large caps for some time, and contrary to expectations, as Elgeti explains: “large caps usually outperform during a period of recovery, but they have under-performed the small caps over the last nine months. We expect this to correct over the coming year 2004.”
But Riley disagrees: “the consensus is that the rally in small/mid caps (market capitalisation up to $10bn (E8bn)) has ended and there will now be a move towards large caps,” he says; “but as the continued throughout 2003, contrary to expectations, and if the economy is stronger than most expected, why shouldn’t it continue into 2004?”
We eagerly await the first quarter’s earnings figures.

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