US domestic politics have dominated equities sector

Potential removal of double taxation paid on dividends gives hope to US investors.

Volatility in US pharmaceutical and healthcare markets has produced mixed results for long/short managers trading equities in this sector. A combination of political and regulatory wranglings over drug manufacturing is being blamed for price movements.

In addition, energy stocks including crude oil are being overvalued as a result of stockpiling in response to the threat of war, as Mike Ward, portfolio manager for the $100m Franklin Templeton US Registered long/short fund, explains. 'We have made money on our short energy and technology positions, and been hurt by our long healthcare and pharmaceutical holdings. The healthcare market was doing okay but then Cigna Corp blew up recently, so there is danger. The sector has had no leader effectively, as the Food and Drug Administration has taken so long in appointing a new commissioner.' At the beginning of November the FDA appointed Jane Henney's after an 18 month vacancy.

In contrast to the Templeton fund's rocky ride in pharmaceutical and healthcare stocks, Neal Smeaton, manager of the $20m US long/short fund at Ailsa Capital Management, says his long positions in this sector have performed well. 'The healthcare sector bottomed out in the summer and pharmaceuticals are now showing valuations far more realistic than a few months back,' he says.

Smeaton says he has missed opportunities for shorting among the information technology stocks and believes he may have been too hasty in pulling out of the sector. But he adds that US consumer apathy has proven a useful trigger in driving other stocks in the market down.

'I regret not being short on technology through the summer. It has gone substantially up since then, but up to July it was dropping continuously. Similarly, large industrial manufacturers have fallen and I wished I had been short on those ' the likes of Caterpillar.

'Over the past three months, the consumer discretionary sector has been good for short positions. In addition, one or two of the auto parts companies have dropped quite dramatically. The homebuilder market has also fallen, and all of these are a result of a continued drop in consumer spending.'

Smeaton believes consumer confidence in the US could get even worse. 'There is the prospect of war, unemployment is rising and real wages are falling. Recent opinion polls have shown the population to be more interested in getting president Bush to pay attention to the economy than war in the Middle East.' Ward expands on this, claiming domestic politics have dominated the US news agenda over the past year.

He says the mid-term elections tested the government's resolve but a bill on dividend taxation is currently working its way through Congress and has been unaffected by the elections. Ward says it could kick-start retail investment in the equity markets. 'There are political events on the horizon, which are positive. The potential removal of double taxation rules paid on dividends could encourage more investment again. At present, both companies and investors are taxed on dividends so, if this is stopped, confidence to hold on to stocks may increase.'

Crude oil has a variety of forces pushing its price around, including overproduction, but Ward believes the war premium being added to its value is more than twice as large as it should be.

'OPEC compliance is very low and this means cheating is high. OPEC countries are overproducing by more than three million barrels of oil per day and this is confirmed by tanker rates rising. In the US, the American Petroleum Institute indicates inventories have normalised, however, the Strategic Petroleum Reserve is thought to have increased by 30 million barrels, while the US military is rumoured to have stock piled nearly 25 million barrels of oil, so supply, demand and inventory analysis suggests oil should be approximately $20 per barrel. A $2 to $4 premium to that base may be justified, but not $6 or $8 per barrel,' Ward notes.