While tightening credit is among the most pressing market challenges, it is only one of sundry factors currently pressuring incorporated earnings, which be in possession of been falling all year.
By Alec Young From Standard & Poor’s Equity Research
While the S&P 500’s newly come banter off its Nov. 20 closing low of 752.44 represents a welcome reprieve in relation to months of relentless selling, we believe a retest of the lows is likely.
Although latter volatility has at least discounted significant proceeds corrosion, as well as a looming global recession, the consensus also expects the economic and profit picture to improve in the promote half of 2009. Should the current worldwide downturn be longer and deeper than expected, we think equities choose be vulnerable to further selling when markets discount a bleaker than expected outlook. Given the unprecedented free play of global de-leveraging, hedging against a “longer and deeper” scenario appears prudential.
In addition, while the S&P 500’s recent valuation of only 12.5 times 2008 estimated earnings may appear cheap by historical standards, the possibility of continued negative profit revisions means current valuations are likely higher than they appear.
The U.S. consumer, whose spending accounts for roughly 70% of economic activity, is in the state betokening pressure — the result of weakening home prices, which we believe have to a greater distance to fall because of a large inventory glut. In addition, international economic growth, whose spent strength helped boost both U.S. exports and S&P 500 fellowship sales, has weakened dramatically, by Europe, the United Kingdom, Canada, Japan, Australia, and New Zealand altogether in or flirting with recession. Overseas household weakness has boosted the U.S. dollar, farther eroding the gain of the S&P 500 companies’ approximately 45% foreign revenue exposure and exacerbating matters.
While reasonableness prices disposition undoubtedly lead an upturn in the fundamentals, we believe the global economic and income outlook needs to at in the smallest degree show tentative signs of stabilization before in any degree lasting rally will ensue. In flimsy of this unprecedented global macroeconomic uncertainty, we keep on to favor a defensive sector allocation.
Consumer Discretionary
We recommend underweighting this sector. Rising concerns surrounding the sagacity and duration of a U.S. recession are fueling ongoing erosion of the sector’s earnings estimates. S&P analysts’ fundamental outlook on the sector is negative, provident their negative outlooks for many industries, including department stores, automobile manufacturers, house appliances, and home furnishings.
Consumer Staples
We recommend overweighting the sector, reflecting our view of above-average earnings growth expectations and profit predictability. With the credit acme showing not at all signs of abating, housing prices continuing to weaken, and the job emporium remaining sluggish, we believe investors may gravitate towards defensive, low-volatility sectors.
Energy
We recommend overweighting the zeal sector, as we think low valuations will lead to a resumption of broader market outperformance. While WTI oil prices have dropped other thing than 65% since July, recent oil prices right and left $50 per barrel are still roughly in line with the beyond five-year average.
Financials
We recommend marketweighting this sector. As a result of the federal government’s efforts to stem increasing investor pessimism, we believe the worst conducive to this sector may be over. We believe that the government’s Troubled Asset Relief Program (TARP), which has involved capital infusions into financial institutions, has lifted some of the uncertainty surrounding the sector.
Health Care
We believe investors should overweight this sector. With our behold that equity mutability inclination likely remain elevated, we esteem investors will reward the sector’s defensive qualities, allowing for better relative consummation. S&P analysts have a positive fundamental outlook on the biotech industry based on an improved outlook for sales and earnings over the nearest 12 months.
Industrials
We recommend underweighting this sector, as we think poor domestic earnings perceptibility is being aggravated by dint of. slowing between nations economic growth. With the U.S. recession accelerating and recessions now under way around the world, we rely upon this increasingly global cyclical sector is vulnerable to p-e contraction as investors increasingly question its future earnings growth outlook.
Information Technology
We inform marketweighting this sector based on our view that slowing global increase and a firmer dollar make outperformance unlikely. Even though the firming U.S. dollar should not vitally hurt near-term results, in our opinion, the related unfavorable sentiment is a worry.
Materials
We recommend marketweighting the materials sector. We put faith in low valuations are scion by dint of. slowing global growth and a firmer dollar, which will likely temper the sector’s receipts and proceeds outlook. S&P analysts have a neutral fundamental foresight for the sector and see it being negatively impacted by slowing economic growth and raw material exact in, for example, Europe, Japan, and the United States.
Telecommunications Services
We recommend overweighting the telecom sector, due to our positive fundamental lookout, its above-average give up, and improving technical readings. S&P analysts receive a positive fundamental outlook for the sector, based on a positive outlook for the integrated telecommunication services industry, which makes up the vast greater number of the sector’session market capitalization.
Utilities
We recommend marketweighting this sector based on its defensive characteristics, its above-average dividend yield, and an improving technical outlook. S&P has a neutral fundamental outlook for the sector, based on our neutral view on several of the industries, including the electric utilities assemblage, that represents not remotely 60% of the sector.
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