Despite earnings growth exceeding expectations in the first quarter of 2005, the price/ earnings ratio of the S&P 500 index has fallen to about 15.5x compared to the mid-20s seen at the peak of the bull market.Kaye says that while earnings growth was predicted to slow this year, it has only dropped from 20% to 15% in the first quarter of 2005, which is double the expectation. “Earnings growth is being driven by improved margins and revenue growth. Consumers are still spending and there is the start of a growth in capital expenditure. Companies have learned to be lean.” Risk aversion and rising interest rates have contributed to a negative return in the S&P 500 this year, however, says Kaye. “The rise in interest rates has had an impact because of the effect on carry-trade investors.” These investors borrow at the short end and then use the money to invest in what they think will be higher-yielding assets. “Carry-trade investors have been liquidating their positions as interest rates have risen,” says Kaye. “The US market is low down the chain but higher rates are leading to investors redeeming positions.” Kaye says he is finding plenty of stock ideas given that valuations in America are at their lowest for eight years. “Everyone thinks of the iPod in relation to Apple. But if it was just about the iPod we may not still own Apple. The iPod has had a positive effect on the Apple Mac computers. “Apple’s retail stores in the US generate sales of $4,000 (2,150) a square foot per year, which is a phenomenal amount. Sales of its desktop computer were up 50% in the first quarter and they only have a 2% market share so they have the potential to grow. Apple also has $7bn in cash.” Kent Shepherd, manager of the Franklin US Equity fund, however, has increased his exposure to defensive stocks, which he says reflects where his team is finding value in the stockmarket at the moment. “We are overweight in Coca-Cola for the first time ever and also now own Anheuser-Busch for the first time. This is because Americans are drinking more alcohol. We are overweight hospital and health services but underweight big pharmaceutical stocks.” Shepherd also highlights discounters. While consumer spending may slow down, Shepherd argues that people still need to buy food, drink and other basic household goods. If they have less money to spend, says Shepherd, they will go to the cheapest shops.