S&P's Investment Policy Committee has a neutral allocation recommendation toward U.S. equities. We believe the expected stimulus to economic growth, earnings, and consumer spending from seven interest rate reductions and a more than $100 billion tax rebate program will be partly offset by concerns surrounding the impact of rising food and energy costs on consumer spending, and the speed with which the Federal Reserve chooses to reverse course and begin to raise short-term interest rates.
Large-cap U.S. equities will likely face stiff headwinds in the second half. S&P equity analysts are projecting an 8% increase in full-year operating earnings for the S&P 500, which is down from the estimated growth of 16% in the beginning of the year. Nine of the 10 sectors in the S&P 500 are projected to record earnings increases, while the Financials sector is seen posting a 24% full-year decline. Only the Consumer Staples and Energy sectors have seen progressive increases in full-year earnings growth estimates.
If there is a sweet spot in the U.S. equity market, however, we think it is the midcap equity arena. Investors believe they can get higher-octane results from the more nimble smaller-cap stocks, as they typically outpace larger-cap issues when the equity market is on the upswing, while also maintaining the more defensive qualities that larger-cap multinational companies traditionally offer during challenging economic periods. Within the S&P MidCap 400, significant disparities are found in the high-flying Materials and Utilities sectors. These two groups each represent less than 4% of the weighting of the S&P 500, but more than 8% of the S&P MidCap 400.
In addition, while the international integrated oil companies dominate the S&P 500 Energy sector, it's the upstream exploration and production companies (those that benefit most from rising oil prices) that dominate the midcap benchmark. Lastly, S&P equity analysts, who cover about 70% of the companies in the S&P MidCap 400 Index, are projecting a 16% increase in operating earnings for the "400" in 2008, as compared with only an 8% estimate for the S&P 500. Despite a higher price-earnings (p-e) ratio on 2008 estimated earnings per share for the midcap index, the PEG (p-e to growth) on 2008 estimated results is more attractive for midcaps at 1 times than the 1.8 times for the "500."
Neutral Outlook
Our outlook for small-cap issues remains neutral, as the increasing likelihood of a delayed recession is expected to cap EPS growth. While the Street estimates call for a 9% rise in operating results (S&P equity analysts cover only about 30% of the stocks in the S&P SmallCap 600 Index), valuations appear a bit stretched to us at 19 times 2008 estimated results, vs. 15 times for the "500."
Growth and Value within the S&P 500
Sectors
S&P 500 Exposure Growth
S&P 500 Exposure Value
Consumer Discretionary
49%
51%
Consumer Staples
57%
43%
Energy
83%
17%
Financials
21%
79%
Health Care
64%
36%
Industrials
42%
58%
Info. Technology
79%
21%
Materials
46%
54%
Telecom. Services
1%
99%
Utilities
10%
90%
S&P 500
54%
46%
Source: Standard & Poor's Index Services