Lower Profit Growth Expected Given Economic Slowdown

Data tracking capital flows from big money managers into funds and exchange-traded funds from Emerging Portfolio Fund Research [EPFR] show that Germany (EWG) was the big winner among developed markets during February. A three month, $1.7 billion buying streak by equity funds and ETFs pushed its average weighting among Global Equity Funds above that of France (EWQ) for the first time in more than five years.

Energy sector weightings continued to slide during February, dropping out of the top five sector allocations. As for flow of funds, Global Utilities Sector funds and ETFs such as (JXI) have been the most consistent winners this year. Equity funds and ETFs were net sellers of $2.7 billion of Chinese equities in February but investors and fund managers retained their appetite for smaller, more defensive Asian markets. Malaysia and Singapore both saw record-setting net buying from these funds.

Will concerns over a weaker economy and corporate profits hurt exchange-traded funds such as (SPY) that track indexes like the S&P 500? The companies in the benchmark S&P 500 index have been increasing year-on-year profits at a double digit rate every quarter for more than four years. However, the record streak is may come to an abrupt end as Wall Street analysts predict an increase of just 5.1 per cent for the first quarter of this year, according to Reuters estimates.

Companies in basic materials, energy and cyclical consumer goods are expected to bear the brunt of the slowdown, due to falling prices and lower demand for their goods.

Many say lower profit growth is to be expected given the slowdown in the economy. Some argue that soft earnings growth need not translate into soft stock markets because valuations will be supported by the recent record levels of share buybacks and merger activity. Solid economic growth in the rest of the world should also help the earnings of US companies with overseas operations since many of them gain about half of their profits and sales from abroad.

Long-term, both the China exchange-traded fund (FXI) and Japan ETFs such as (EWJ) will be affected by how these two giants get along politically and economically. Japan's economic recovery has been in large part due to its growing exports to China and China is still somewhat dependent on Japanese capital and technology. The thawing of relations between the countries is welcome but deeply held historical animosities will take a long time to simmer down. Conflict over energy sources in the East China Sea could be particularly explosive. But there is movement towards better relations with Japans Prime Minister Abe pledging not to visit the Yasukuni Shrine and China's Premier Wen Jiabao will make the first visit by a premier to Tokyo and Kyoto on April 11th-13th in more than six years.