With Wall Street expecting US companies to post earnings growth of 11.5% in 2003, optimism seems to be the order of the day – despite looming war with Iraq and continued bad news on the macro economy. And it remains to be seen whether President Bush’s $674bn (E639bn) “fiscal stimulus package” – that’s tax cuts – can jumpstart the situation.
And there’s no denying that something needs to be done. CIBC World Markets maintain that the underlying fragility of the US economy combined with the possible conflict with Iraq will make for a very uncertain equity market in 2003. CIBC’s chief economist Jeff Rubin says: “The US economy is still struggling despite having the benefit of 41-year low interest rates and one of the largest tax cuts in US history.”
The tax-cut plan, unveiled last month, featured the elimination of personal taxes on dividends of US investors and the moving forward of previously announced tax cuts.
Rubin says spending is “flat as a pancake” in the wider US economy, which has been ignored by the stock market’s desire to back Bush’s tax-cut plan. “While the stock market can rightfully cheer about the elimination of federal taxation on dividends, the real contribution of the Bush package to sustaining any rally will be through its impact on the economy. And on that score, it pales in comparison to the 2001 initiative.”
Rubin says the package is likely to provide no more than half the near-term economic impact support that the fiscal policy offered in 2002.
Merrill Lynch takes a different tack. In a research note, Merrill Lynch Investment Managers’ chief investment officer Bob Doll says: “After these three years of decline, in our opinion, US stocks should benefit from both stimulative fiscal and monetary policy as well as more reasonable valuations, particularly compared with US Treasury issues and cash.”
US Bancorp Piper Jaffray estimates that the tax cuts would add about $50bn to the 2003 US deficit. “Together with an invasion of Iraq that could also cost $50bn, the 2003 deficit would climb to about $275bn,” says its senior research analyst Brian Belski.
Other than the tax cuts, Iraq will play on the market’s mind. “War might introduce risks in the form of higher energy prices, but the issue is how high and for how long,” says CIBC World Markets’ chief investment strategist Subodh Kumar. “Prolonged oil prices in the $40 per barrel range would soak up cash from consumers and industry and increase inflation fears.”
Piper Jaffray’s Belski sums it up. “Continued uncertainty surrounding the Iraqi situation and tremendous uncertainty with respect to a revival in business spending may serve to keep a lid on growth as 2003 unfolds.”
Corporate earnings will as ever be under the spotlight. Analysts are optimistic about the prospects for company profits in 2003. Kumar says: “We expect earnings recovery to drive equity outperformance into 2003, with markets becoming more forward looking.” He sees recovery coming from the return of “efficiency-driven” corporate reinvestment in the form of capital spending.
Doll sees an “upside surprise” in corporate earnings, driven by cost cutting, productivity gains and modest revenue improvement. “We believe that October of last year did in fact mark the low for equity markets as well as lows in interest rates.” An accommodating monetary policy, low inflation, improving profitability, improved valuation levels and stimulative fiscal policy make the case for higher equity prices. “Intelligent trading and technical asset allocation will be rewarded.”
Piper Jaffrey’s Belski shares the glass half full attitude about stocks. “We believe that corporates can improve throughout the year, especially with a stabilisation of the equity markets and a successful resolution to the Iraqi situation.”
He says earnings growth for S&P 500 companies rose to 4.8% in 2002, up from 2001’s -18.1%. The consensus expectation on Wall Street is for US companies to post earnings growth of 11.5%.
Kumar adds: “Stronger equity markets could unfold as investors become more forward looking on earnings recovery, stemming from the yeoman work of the US consumer, company cost cutting since 2001, the tightening of regulations and the visible punishment of transgression since March 2002, and the potential for synchronous global recovery in 2003.”
In sum: “In our view, the earnings cycle is likely to improve into 2003 and beyond” with increased defence spending a possible spur to spending overall.
The final piece of the jigsaw for markets is the state of the US currency.
At CIBC, Kumar says the dollar falling into the 1.15-1.20 range against the euro could mean that capital outflows from the US. “A further US dollar slide would need policy mistakes. We would expect a combination of more favourable US economic data and market expectations for a speedy conclusion to a war in Iraq to provide some support for the dollar,” says Jasper.
Data released has provided some encouragement, suggesting business spending may be recovering.
The last word goes to Piper Jaffray’s Belski, who says: “We believe investors should be positioned for a net flat, yet volatile environment over the next several months, whose mood, direction, and ultimate performance will be dictated and defined by the indecisive back-and-forth blather.”

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