ThesecondmilestonewastheFTSE100’sbreachingthe6,500levelonitswaytohittingmulti-yearhighs,inkeepingwiththebuoyancyalreadyapparentacrossotherglobaldevelopedequitymarkets。

Thesurprisetousisthatequitiescontinuetoperformaswellastheyarewhilethemacroeconomiccloudsdarken。

Thisenvironmentlookssuspiciouslyliketheexactoppositeofconditionswhichprevailedinthelatterpartof2002。

Backinlate2002/early2003we(andothers)werewritingaboutthepossibilityofaseveredeflationaryspiralemergingwhich,unlessdrasticmacroeconomicmeasuresweretaken,couldresultinadownwardslideintodepressionconditionssimilartothoseexperiencedinthe1930s。

Atthattimeglobalcentralbankers,followingtheFed’slead,werecuttingbaseratesaggressivelyinordertopre-emptsuchaspiralevolvingandequitymarketswerereactingnegativelytothepossibilitythatcentralbankersweregrapplingwithconditionswhichwereoutoftheircontrol。

Atthesametime,macroeconomicdatawasbeginningtogivetheimpressionthatacornerhadbeenturned。

WhilstittooktheUSinvasionofIraqtoactasthecatalystforequitiestobegintheirrecoverywhatstruckusthen,asnow,wasthelageffectbetweentheclearappearanceofimprovingfundamentalsandthelightingofthe“bluetouchpaper”undertheequitymarket。

Nowweseethealmostexactoppositeatwork。

Equitymarketshaveenjoyedaprolongedrevivalandmulti-year(andinsomecasesalltime)highshavebeenachievedandbuiltupon。

Atthesametimethemacroeconomicpicture,tosomeextentintheUKbuttoamuchgreaterdegreeintheUS,hasdeterioratedmarkedly。

WhilstweacknowledgethehighlysupportivenatureofongoingmergerandacquisitionactivityandthepossibilitythatAsia,andtoalesserextentEurope,mightbeabletodecouplefromaUSslowdownwearenotentirelyconvincedthateitherissufficientlyguaranteedastoensurethatequitymarketscancompletelyextricatethemselvesfromdeterioratingfundamentals。

Thepurposeofthisnoteistolookattheextenttowhichthosefundamentalshavedeterioratedasameansofassessingbyjusthowmuchsharepriceshavebeenlookingintheoppositedirection。

Wecannotbelievethatthedollar’songoingweaknessanditsadverseimpactonthetranslationofdollarrevenuesandprofitsbackintosterling(oreuros)canbecompletelyoffsetbyfurtherimprovementsinprofitmargins。

UKandEuropeancompanieswithsignificantdollarexposuremustbepotentiallyvulnerabletothatcurrency’sslideontheforeignexchanges。

HowseverehastheUSeconomicslowdownbecome?

AnnualisedUSeconomicoutputisexpectedtohavegrownbyjust1。

7%overQ12007,amarkeddeteriorationfromthelevelsrecordedtwelvemonthsagoandindeedthe4%+growththatmanywereanticipatingatthebeginningoftheyear。

ThecollapseintheUSsub-primemortgagesectorhasprovedasignificantcontributoryfactor。

Ourearlierview,thatthiscollapsemighthavemorewidespreadimplicationsthanthemarketinitiallythought,appearstobebeingbornoutbyrecentdatareleases。

Notably,theNationalAssociationofHouseBuildersindexgivesareadingofjust33inApril,downfrom36inMarchandatitslowestlevelsfortheyearinclearrecessionaryterritory。

ThenumberofforeclosuresincreasedoverQ1from83,154inQ12006to168,829reflectinganaggressivetighteninginmortgagelendingstandardsacrosstheboard。

AnecdotalevidencefromeveryhousebuildingcompanyacrosstheUSindicatesthatthatspringactivityhasbeenflatonitsbackindicatingaweakenvironmentformanymonthstocome。

Furtherevidencethattheweaknessinresidentialpropertyisspreadingisprovidedbyweeklyjoblessdatawhich,althoughinpartweather-related,spikedtoatwomonthhighinmid-AprilandtheMarchretailsalesdatawhichshowed-3。

2%annualisedoverQ1,against+5%inQ42006and+7。

9%overQ12006。

Retailsaleshavenowslowedineachofthepastfivequarters,aneventwhichhasn’thappenedinthepasttwentyyears!

Onbalance,wesuspectthatannualisedUSGrossDomesticProduct(GDP)growthmayemergebelow1。

7%giventheweaknessacrosssomanyindicatorsandthatQ2data,havingstartedsoflat,suggestsprospectsforarevivaloverthesecondquarterdonotlookparticularlypromisingeither。

UnliketheUKexperience,USinflationarypressuredoesseemtobeeasing。

MarchCPIdatashowedamonthonmonthincreaseofjust0。

1%(roundedupfromjust0。

061%)sufficienttotaketheannualisedfiguredownfrom2。

7%tojust2。

5%。

ThislevelisstillabovetheFed’scomfortlevelbutisatleastheadingintherightdirection。

TheGreenspanFedtendedtolookthroughCPIdataasitregardedthereleaseasbeingtoolagginganindicator。

NotethatcoreinflationtendstolagtheUSeconomiccyclesomuchthatinfiveofthesixrecessionsoverthepastfiftyyearsitrosepointonpointonthewayintoeachdownturnonlytocollapsethefollowingyear。

Thereasonforthisisthesignificantweightaccordedtorents(c40%)intheheadlineCPIand20%inthecorerate。

GiventheveryslowpaceatwhichhousingcomponentstendtoimpactonCPIitislittlewonderthatUScentralbankersoptedtolookinsteadatactivitymeasuresinthebroadereconomybeforetakingdecisionsonbaserateswhichimpactonlyafterafurtherninemonthsorso。

Areequitiesignoringaneconomicslowdown?

Despitethesanguineequitymarket,bondmarketactionappearstobetellingadifferentstory(again)。

ThetenyearUSTreasurybondyieldhashitlevelsnowherenearprevioushighsevenafterthelatestsurgeingoldandcommodityprices,risingequitymarkets,strongjobsdata,afuturesmarketstilllargelypricingoutthechanceofFedbaseratecutsthisyearandafallingdollar。

Bycontrastequitieshavehitnewhighsagainstrisinginflationexpectations(hereintheUKandinEurope),risingbondyields,downgradedGDPgrowthforecasts,higheroilpricesandearningsestimatesunderremorselessdownwardpressure。

Hedgefundmanagersmayclusteraroundbullishcartconfigurations,privateequitymaytakeadvantageoftheplentifulsupplyofcheapdebt,equityinvestorbraggadociomayhaverecoveredtopre-2000levelsandyetthelessonfromrecenthistoryisthatinthemediumtermeconomicfundamentalstendtoreassertthemselves。

Justasequitiesignoredarevivingeconomicbackdropinlate2002onlytorecoverstronglyonceactivitybecamestronglyapparent,mightequitiesbeignoringthedeterioratingUSmacroeconomicenvironmentnow,onlytostrugglewhenitbecomesevenmoreapparentinthefuture?

ByJeremyBatstone,DirectorofPrivateClientResearchatCharlesStanley

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