A Slowing
Economy Favors Large-Cap Companies with Visible Earnings
The
market action in the first half of 2000 has been among the most
volatile in history and, generally, has resulted in lackluster
returns for many investors, says Terry D. Sandven, Portfolio
Strategy Group, U.S. Bancorp Piper Jaffray Inc. Despite this
volatility and profitability, Sandven continues to believe that
the fundamental conditions are in place for share price advancement
of many companies, particularly large capitalization companies
with high earnings visibility, between now and year-end.
The following is Terry
Sandven's outlook for the remainder of the year and the sectors
and the stocks within that are best positioned to outperform
the market.
Outlook:
Our moderate economic growth outlook, and subsequent optimistic
outlooks for both the equity and fixed income markets for the
remainder of 2000, are grounded in solid year-over-year earnings
growth. The Street estimate for earnings growth in 2000 over
the 1999 level is 13.2%, essentially in line with the Street's
13.3% increase estimated in June. We believe it is conceivable
for S&P 500 earnings growth to trend upwards of 15% in 2000,
above Street expectations, primarily due to increased productivity.
Capitalization:
We believe outperformance in the second half of 2000 will
be led by large-capitalization companies with visible earnings.
In an environment of strong economic growth, as was the case
during the first half of 2000, it is understandable that share
prices of small and mid-sized companies would excel due to a
broadening of demand and encouraging expectations. This broadening
of demand and encouraging expectations will likely be tempered
in a slowing economic environment, as is forecasted for the second
half of 2000. A slowing economic environment typically favors
larger-capitalization companies with visible earnings.
Sector Rotation:
The transfer or rotation of funds from one sector to another
is alive and well. Note that some of the bet performers in 1999
are among the worst performers year-to-date in 2000. Perhaps
most notable are the reversal of fortunes between technology
and health care. Technology has posted a year-to-date return
of 2.9%, significantly below the 73% return posted in 1999 as
well as in 1998. In contrast, health care has posted a leading
year-to-date return of 22.9%, significantly above the -6.0% return
posted in 1999. Importantly, sectors that underperform in one
period often outperform in another, and vice versa. This occurs
perhaps for several reasons, such as profit-taking and rotating
funds among sectors depending upon changing economic conditions.
Technology:
We continue to like the long-term outlook for technology
and believe that it will be technology that leads the broad equity
markets to meaningfully higher levels. We regard the current
correction among technology issues as being normal and healthy.
After all, it is simply unrealistic to expect annual returns
of 73% to be the norm. We also regard select technology-related
telecommunications companies to be attractive at current price
levels.
Financials: The sector that seems, categorically, to be the best positioned to outperform over the near-term is financials. The group obviously has been out of favor for the past year; the trend of increasing interest rates has certainly damped down the performance of many financial companies in 1999 and early 2000. However, the environment is changing. Financials continue to exhibit solid earnings growth, despite generally weak investment banking activities. Financials should benefit from a more stable interest rate environment; while the likelihood of another Fed rate hike on August 22 certainly exists, additional rate hikes in 2000, especially in an election year, seem increasingly unlikely. Lastly, the group stands to benefit from a rotation back into the group, similar to the rotation that occurred to health care in early 2000 at a time when limited interest was given to that group. We anticipate a rotation back to financials and believe that the sector will outperform during the second half of 2000. Our favorites include Chase Manhattan, CitiGroup, Washington Mutual, and Wells Fargo.
