By Yaser Anwar, CSC of Equity Investment Ideas
This week I’d like to talk about issues affecting
- The downturn in housing so far hasn’t had a measurable impact on consumer and capital spending. The good news is consumer (thanks to low unemployment rate and improving real wages) & corporate (thanks to stellar profits & earnings growth) spending alongside exports (thanks to growth overseas, partly aided by the weaker dollar) slowing growth is unlikely to develop into anything worse.
- We have also witnessed softening core inflation thanks to deep discounts offered by retailers in areas such as clothing, autos and electronics. The retailers have been able to absorb those discounts due to elevated cash positions & consumers insatiable appetite to spend. One can also look at the low inflation rate to help explain strengths in consumer spending.
- Furthermore, discounting will continue to act as a drag on inflationary pressures, while rent inflation, which is elevated, may start to head downward. On the housing side- the weakness has already cut GDP growth by more than 1% point in the 2nd H of this year. It will remain a drag on growth throughout much of 07, although with diminishing impact as the year progresses.
- An interesting trend to note is the divergence between EPS & revenue growth. What’s interesting about this trend is that the divergence is not very typical in the late stage of the cycle, since firms typically find it increasingly hard to contain costs. To a large extent, this gap was bridged by a significant acceleration in the pace of buybacks & M&A activity during the second half of 06.
- Even with the slowing GDP growth in the US, growth across the world (BRIC & most notably Eurozone) has remained strong so far. Growth in 07 will be driven by cash holdings of corporations used for buybacks/dividends, huge horde of cash utilized for LBO/M&A activity (According to Dealogic- In the past four years global M&A activity has risen from US$75 billion/month to US$300 billion with the average deal size has risen from US$33 million to US$123 million, the number of deals per month is up 50%– a trend that shows no signs of abating, which could be a catalyst to support equity prices) alongside modest multiple expansions & EPS trends.
- With GDP growth slowing We have seen robust short-term gains from the May doldrums and investors realize that EMs are not immune to a correction. We may see some downside surprises due to weakness in German growth thanks to higher taxes early in the year and the risk of further tightening from the BoJ than markets anticipate.
- In the longer term if “irrational exuberance” gives way to caution, investors can expect global markets to provide rewarding returns for investors in years to come, especially China & India. However- China’s GDP growth slowed to 10.4% in the 3rd Q from 11% in the 1st H of the year. Investors shouldn’t be surprised by a further deceleration to 9.5% next year due to the government’s desire to dampen investment spending.
- Indian growth is expected to come around 8ish% from 9% this year but the positive trend to note is unlike China, much of India’s growth is consumer led. While India’s inflation rate is a little higher than China’s (5% vs 2%), there are very few signs of overheating in either economy.
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