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Abundant stock opportunities despite negative macro backdrop

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With significant US macro issues remaining, it is difficult to be bullish at a country level but opportunities abound at a micro/company level and in 2012 we could see market returns of 10-15% despite this negative macro backdrop, says James Abate (pictured, Manager of the PSigma American Fund…

Without the introduction of an exogenous shock, we reject the argument that the US economy is flirting with a double-dip recession but, instead, is in a period of moderate growth without the negative consequences of inflation.  We simply do not see the typical excesses of over-investment as well as a more restrictive interest rate or lending level environment to push the economy into an outright contraction.  Yes, housing and a host of other domestic economic indicators are still low but we’re not seeing evidence of further deterioration.  Furthermore, the global nature of companies within the S&P 500 index allows them to focus on those areas of the globe which are growing.  This favourable earnings outlook, in turn, will provide the backdrop for equity market appreciation in line with overall profits growth.
 
Reasons to be cheerful at a company level include:
 
Multiple expansion (re-rating) on stocks delayed, not abandoned, but linked to alleviation of macro concerns

Impact of globalisation on S&P 500 profits momentum (42% of revenues derived from foreign sources)

Presidential election years are bullish, delivering positive returns 81% of the time with average returns of 11%

We continue to favour technology, which is the Fund’s largest sector position at approximately 33% vs. a 20% weighting for the S&P 500 – IBM is the Fund’s third largest holding

Valuation gap to narrow benefitting large caps vs. small caps as investor preference for globally-oriented firms rises
 
The profits reporting season for US companies has delivered some stellar results. The vast majority of companies in the S&P 500 Index posted results that exceeded analysts’ average earning and revenue estimates. Why is this? The answer is simple, the restructuring and streamlining of corporations we witnessed during the recession of 2008-9 is the most efficacious and broad-based I have seen in my career. Profit margins and asset efficiency are expected to surpass prior peak levels which are still a good deal higher than current levels.
 
We continue to remain underweight in sectors we feel are the most exposed to selective and unpredictable Government intervention, such as financials, healthcare, and utilities. This will be a dominant theme – the Government will seek to place restrictions and pressure on the returns on equity of companies in areas where the US electorate would appear to be disapproving of excess profits, especially where taxpayers’ monies were used to assist in stabilising the companies less than two years ago.  Despite the continued focus on the financial sector, a significant laggard this year and the valuation attractiveness of the sector, we do not see it leading the market higher.
 
In summary, the US is standing head and shoulders above other developed markets due to its dynamism in reacting to the recessionary conditions of 2008-9 as well as the global footprint for most US multinational companies, and US businesses should continue to benefit from this relative strength.
 

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