1st August 2013
Amid all the concerns about tapering, investors need to watch out for weakening US growth and its impact on earnings says Russ Koesterich, BlackRock’s Chief Investment Strategist.
In a note issued this week, Koesterich says investors remain highly focused on Federal Reserve policy and specifically, what will happen to the economy and the markets when the central bank pulls back on its asset-purchase programs.
Yet he says while these concerns remain valid the economic data continues to be mixed. He says two strong reports – new home sales and durable goods orders were solid but existing home sales were weak and the Chicago Fed National Activity Index – a forward-looking metric that has historically done a good job of forecasting future growth – came in weaker than expected.
“This marked the fourth month that this index had a negative reading, and it suggests to us that after a weak first quarter and an even weaker second quarter, the third quarter is off to a sluggish start.”
He says that this weaker trend in economic data raises the prospect that corporate earnings estimates being scaled back.
“So far, second-quarter earnings results have been passable, but it is important to remember that companies are beating already-lowered expectations. Analyst expectations for the third and fourth quarters are considerably higher and may need to be ratcheted down if growth disappoints. This scenario creates a potential risk for US stocks”.
However Koesterich says there are better prospects for global growth.
“We are seeing some encouraging signs from outside the United States. In Europe, Spanish labour market and German business data suggest that the region is stabilizing. Should this trend continue, it could mean that continental Europe – which represents approximately one-fifth of global GDP – will stop being a drag on the world economy.
Japan is an even more likely catalyst. The note adds: “Last week, Japan reported modest inflation, a good sign that stimulus efforts by the Japanese government and Bank of Japan (BOJ) are starting to work. Faster growth in Japan would have a real impact on global growth as Japan is the world’s third largest economy.
“Furthermore, the extraordinary efforts of the BOJ should help mitigate the potential loss of monetary liquidity that could come about if and when the US Fed does pull back on its bond purchases. The BOJ is currently purchasing seven trillion yen a month worth of bonds. To put that number in perspective, relative to the size of the Japanese economy these purchases are roughly three times the size of the Fed’s monthly purchases. Additionally, while the Fed is likely to slowly taper (or slow the rate of purchases) over the coming months , the BOJ has indicated that it intends to keep up its bond-buying program for at least another two years”.
The firm suggests the focus should be on international stocks, mega caps and technology.
“Those investors who are dramatically underweight international equities, this may be a good time to consider increasing their allocations to non-US stocks. Second, if we do see improving growth from the rest of the world, large and mega-cap US stocks – particularly those in the technology sector – would be poised to benefit, since these companies derive a significant portion of their revenues from overseas”, the note adds.