January Blues
February 17th 2010
A betting man could therefore be forgiven for wagering that equity markets would have continued their upward march in January. So why are we in the midst of the first correction in the current bull market?
Ignoring the macro scene for the moment, it has become apparent that the market had largely discounted impressive results and has been a little underwhelmed by reported earnings. The share price reaction of companies reporting in-line has consistently been negative, whilst those beating have seen limited upside. For those that miss, the reaction is often violent. Alcoa‘s shares tanked 12% after their disappointing results and are now 27% off their mid January highs. Further to this, accompanying statements remain cautious. Unsurprisingly few CEOs are willing to put their head above the parapet and paint a rosier picture even if their order books would suggest such an outcome.
Having listened to a number of highly regarded fund managers in the past month, a large percentage of whom have endured a torrid two years of relative performance, the overriding theme is that stock picking is set to return as the primary driver of share prices in 2010. Well it hasn’t in January. Macro news continues to dominate prices. Obama’s war on the bankers may be a vote winner but the uncertainty regarding future legislation is a huge black cloud over the financial sector and almost every asset class. The miners, many of which had been pricing in a strong recovery in global demand, are suffering as fears grow that China will have to hit the brakes in order to prevent overheating. To add further uncertainty sovereign default risk remains at the forefront of concerns. The cost of insuring Greek national debt, as measured by the credit default swap market, surged last week to levels comparable to that of Dubai’s at the time of their bailout by neighbouring state Abu Dhabi.
Technically there have also been very interesting moves over the month. The FTSE 100 and S&P 500 have broken down through their 100 day moving averages, key levels that have provided support since last April. Whilst in the currency markets, the dollar index has moved sharply higher, through its 200 day and to a six month high. Further weakness in share prices over the coming weeks is likely, however, it is not all doom and gloom.
US GDP picked up sharply in the fourth quarter, growing at an annualised rate of 5.7%, whilst manufacturing data continues to impress. As with all the emerging markets China will have to continue tightening policy, however, concerns for the economy overheating are almost certainly overdone. With 60% of GDP currently accounted for by infrastructure spend, much of which is a result of policy stimulus, China remains flexible and able to influence the overall direction of their economy. We also have M&A back in the market. At the moment corporate to corporate but last week’s developments in the private equity sector were also encouraging. Having spent the last 24 months in the wilderness, deals totalling £1.9bn have been announced over the past seven days (up to Jan 31st).
Historically, the equity market’s performance in January has set the tone for the year as a whole. Whilst there is a low degree of confidence whether the market will be higher or lower in 11 months time, many observers concur with the view that company fundamentals will become increasingly important in 2010. Valuations are no longer cheap but equally they are not prohibitively expensive. In the UK investors can still buy a number of global leading businesses at inexpensive multiples. Any further weakness in share prices will provide an opportunity to add to such names.
