Economies stay hot but investor sentiment turning down

Recent indicators show that economies are still relatively hot, but not investor sentiment.

For March, the Labor Department reported this week that US producer prices rose 0.7 percent from February while consumer prices rose 0.6 percent. Energy prices were largely responsible for the large increases. Core prices excluding food and energy rose at a slower pace -- core producer prices were up only 0.1 percent in March, although core consumer prices were still up a relatively high 0.4 percent.

The Beige Book report by the Federal Reserve on 20 April alludes to similar inflationary tendencies: "Price pressures have intensified in a number of Districts, and most report that high or rising energy prices are a concern across sectors."

Other parts of the report show that the US economy remains strong. Business activity reportedly "continued to expand from late February through early April". More than half of the Districts reported that retail activity was up. Manufacturing activity was described as "ahead of year-earlier or previously-reported levels". The report also noted that in general, "firms in the service sector enjoyed a moderate increase in activity". In real estate, residential real estate markets was reported to be "strong across most of the country, while commercial real estate conditions varied". It also reported that for most Districts reporting on financial services, "demand for loans increased across a range of categories" and other banking indicators "were holding steady or improving in some cases".

On 18 April, though, the Commerce Department did report a large 17.6 percent fall in housing starts in March. Some analysts, though, point out that this figure is volatile and, in any case, the number of starts remains at a high level.

If the US -- one engine of global economic growth -- remains hot, the other -- China -- is no less so.

On 20 April, the National Bureau of Statistics announced that China's economy grew 9.5 percent in the first quarter of 2005, the same rate as for all of 2004. Fixed asset investment increased 22.8 percent in the first quarter, just slightly slower than the 25.8 percent growth rate for 2004.

These figures add to the likelihood of further tightening in both the US and China. And this is surely on the minds of investors.

In my previous commentary, "Analysts slightly bearish towards equities", I had highlighted a number of bearish views. Here is more.

On 19 April, Bloomberg columnist Chet Currier wrote an article entitled "Weitz, Dodge, FPA -- Scary How Wary Top Funds Are". In it, he wrote: "One striking aspect of the recent decline in stock prices is how many top-performing fund managers saw trouble coming."

Currier quotes Wally Weitz of Weitz Value Fund and Weitz Partners Value Fund as saying: "Almost everything looks expensive." And Dodge & Cox Stock Fund chairman Harry Hagey and president John Gunn was quoted as writing in their annual report: "Looking out over a three- to five-year period, we continue to believe that returns from the broad equity market will be modest and could be punctuated by some unpleasant negative contractions." And FPA Capital Fund manager Bob Rodriguez was quoted as saying: "Both in bonds and equities, we are taking extraordinary measures to protect capital, since we believe we are in a period of diminished investment returns."

Consensus, you say? Contrary action indicated?

Not necessarily. Remember that these are top-performing funds. According to Currier, the Weitz Value Fund returned 16.7 percent a year over the past 10 years, the Weitz Partners Value Fund returned 16.6 percent, the Dodge & Cox Stock Fund returned 15.8 percent and the FPA Capital Fund returned 17 percent. For comparison, the Standard & Poor's 500 Index returned 10.8 percent a year over the same period.

Merill Lynch has found similar pessimism as well. In its recent survey of global fund managers, it found increasing pessimism about economic growth, corporate profits and prospects for equities.

Whereas in March, a net 11 per cent of managers expected the global economy to grow in the next 12 months, the latest survey found a net 20 per cent expect it to slow. 52 per cent of respondents expected the outlook for corporate profits to deteriorate over the next 12 months, compared to 39 percent in March. 30 per cent predicted margins will shrink, compared to 18 percent last month.

59 per cent of managers said they were overweight in equities, down from 68 per cent in March. 65 per cent were underweight in bonds, the same as last month.

Recently, global equity markets have been making relatively large moves, mostly on the downside. Yesterday, for example, the Standard & Poor's 500 fell 1.3 percent.

The on-going global equity bull market has been resilient so far, and fund managers have only gradually trimmed their long exposure to the market. Let us see whether things will change from here on.

Analysts slightly bearish towards equities

A wide diversity of views on the outlook for equities is normal. However, there seems to have been some convergence of views lately, mostly towards the bearish side. Nothing extreme enough, however, to provide a reliable indicator, contrary or otherwise.

This week's issue of The Edge Singapore illustrates this point. It carries five articles describing the investment outlook from different perspectives. None is particularly bullish, and some are bearish.

The first article is from DBS Bank economist Dr Fong Cheng Hong. In the article, she recommends that investors "stay defensive". She thinks that the outlook is clouded by fears of a sharp rise in oil prices, inflation and interest rate hikes. She recommends being overweight in commodities, neutral in equities and underweight in bonds. Among equities, she is overweight Europe and Japan, underweight the US and neutral on Asia ex-Japan. Within Asia ex-Japan, she likes Indonesia, Singapore and Taiwan.

The second article carries an interview with Mauro Ratto, chief investment officer for Europe, new Europe and Asia at Pioneer Investments. In the article, Ratto is quoted as saying that he sees western developed markets as "entering a phase of low yields and low returns". While he thinks that ""there is not too much scope for top line growth, or further cost cutting", his main concern is rising interest rates. He thinks that investors are likely to be nervous until interest rates peak. Then "things will get more interesting", he says. "But at the moment, we prefer to be cautious."

The third article is by Michael Kahn, who looks at technical indicators to conclude that stocks are likely to head lower. He says that "the half of the year that is historically kind to stocks is now about over, and the half of the year that is not so kind is about here. The tide has turned". In addition, in the four-year cycle, or presidential cycle, the first year after the election -- which we are now in -- tends to be "a rough one". For example, there were major bottoms in 1998, 1994, 1990 and 1982 -- the exception being in the crash in 1987, which came late. Otherwise, this cycle indicates a low "in the latter half of 2006, and to get there from the current highs there is only one direction -- down".

The fourth article is by Edgar Ortega. It looks at the survey results from Investors' Intelligence, and finds that the percentage of bullish newsletter writers fell to 47.9 percent in the last week of March from 51.6 percent. That represents the lowest reading since the week ended 3 September. Bearish writers, on the other hand, rose for a fourth week to 29.2 percent from 28 percent. The gap between bullish and bearish sentiment was 18.7 percentage points, whereas it had been as high as 43.3 percentage points in December. Ortega notes that Investors' Intelligence considers a gap of 10 percentage points "normal". In other words, sentiment among newsletter writers appears to be moving from away from a bullish extreme towards a more "normal" one.

The fifth article is an interview with renowned technical analyst Martin Pring. Alluding to the same four-year cycle that Kahn mentions, he says that "it is possible that we will get one more new high in the Dow before the end of the year. However, 2006 is a low point in a very reliable four-year cycle, and so I see prices lowering over the next 18 months." He adds that the market is in the stage that is "bearish for bonds and stocks and bullish for commodities. About half the time, stocks rally a little in [this stage] and in the other half, they decline".

To sum up, of the five articles, only those involving views by Kahn and Pring could be said to be outright bearish -- although Pring does concede to the possibility of one more new high -- while Ortega's article indicates overall sentiment among newsletter writers as mildly net bullish but deteriorating.

We have looked at opinions expressed in The Edge Singapore. In a commentary on 14 April, Peter Brimelow at MarketWatch provided some more views from other sources.

Dow Theory Letter's veteran Richard Russell was quoted by Brimelow as saying: "Both the Dow and the Transports now well under their 50-day moving averages. They will probably test their 200-day moving averages. The 200-day MA has been a big support for a great many stocks on the decline so far. Let's see if she holds."

So Russell is still waiting for the market to give him the signal. The same is true for Michael Burke of Investor's Intelligence. Brimelow wrote: "[R]ecently he wrote, echoing Russell, that the Dow and the Standard & Poor's 500 Index must hold above their rising 200-day averages. Burke added that his short and medium term indicators were bearish."

Brimelow also quoted Dennis Slothower of On The Money, "one of the more successful newer services", as saying: "One of my concerns has been the breaking point at which an economic contraction begins. I think we might be there. There is just more and more evidence that a slowdown in the economy is occurring. I have been worried that the growth in the money supply over the last quarter was too weak. Investors are starting to see that a contraction could be in the cards near term and that earnings for the last quarter are likely to disappoint overall."

Finally, Brimelow cited a sentiment indicator: "Last night, the Hulbert Stock Newsletter Sentiment Index (HSNSI), which reflects the average stock market exposure among a group of short-term market timing letters, stood at negative 2.4%. On average, these letters were net short the market. This is roughly in the middle of the sentiment range, far from the extremes that might suggest a clear contrary indicator."

So, like the articles in The Edge Singapore, overall, you could say that there is a slight bearish tilt in the views of those that Brimelow polled, which is consistent with what the HSNSI indicates. And, as Brimelow pointed out, that is not enough to provide a clear indication of the market's likely direction.