x Abu Dhabi, UAETuesday 25 July 2017

The US economy is down - but not out

Sitting on a mountain of debt, the US economy has entered hard times. But an improving market and strong corporations may still hold promise for investors.

Big US companies, such as General Motors, will cash in on rising consumer demand from emerging markets.
Big US companies, such as General Motors, will cash in on rising consumer demand from emerging markets.

Sitting on a mountain of debt, the US economy has entered hard times. But an improving market and strong corporations may still hold promise for investors. Harvey Jones writes

The US is on the brink of meltdown. Its addiction to debt and deficit spending has brought it to its knees. Social unrest is growing, and the fissures between rich and poor are widening by the day. The world's economic superpower will be overtaken by China in 2025 and India by 2050, as wealth inexorably spreads from West to East.

The world's sole superpower is finished. That's what the doomsayers and self-appointed Cassandras are telling us, but should investors listen to them?

The US is certainly going through a rough time. Its national debt has just soared past US$14 trillion (Dh51tr) for the first time ever, growing $1tr in the past seven months alone. Once you include another $1.15tr in state and $1.7tr in local debts, the figure hits an even more mind-bzoggling $16.85tr. The country's annual budget deficit is a mighty $1.3tr a year, although some put it as high as $2tr or even $5tr.

Either way, it's a lot of dollars.House prices have plunged 30 per cent since the credit crunch and are still falling - 2 per cent in the past six months. Unemployment did fall slightly from 9.7 per cent to 9.4 per cent, according to data released in January.

Americans are angry. But while the country is in crisis, its stock markets aren't.

The Dow Jones returned 11 per cent in 2010 and ended the year on a high, after rising 5 per cent in December alone. US markets also started 2011 in a positive mood, so is there more to come?

The US has a lot of catching up to do. It has been thrashed by emerging markets for the past decade.

Over the past 10 years, the US delivered an average annual return of just 0.37 per cent, according to MSCI, a leading provider of investment-support tools for investors worldwide. This compares with a thumping 11 per cent a year in China, 16 per cent in India, 17 per cent in Russia and 19 per cent in Brazil.

Ironically, some claim this past underperformance could work in favour of the United States.

The Federal Reserve's decision to launch an additional $600 billion of quantitative easing in November (QE2) provoked a fresh flow of money into emerging markets, which now look overpriced.

This could be a good time to shift your money into the US, says David Coombs, the head of multi-asset investments at Rathbone Unit Trust Management, based in the UK.

"With emerging markets looking expensive and inflated by hot money, now is the time to take profits there and buy the US.

"Valuations are realistic, and strong fiscal stimulus is likely, which could provide a massive fillip for the US. I'm convinced the US has the potential to surprise on the upside."

Mr Coombs believes US policymakers will look to stimulate employment by cutting corporate taxes, and this will help to underpin the stock market.

With Republicans in charge of the House of Representatives after the November midterm elections, President Barack Obama will be forced to move to the centre ground and cut government spending.

The political timetable could also work in favour of investors.

Share prices typically rise in the third year of a first-term presidency, as he or she looks to stimulate the economy in a bid to ensure re-election, says Jim Cullen, president of US-based fund managers Cullen Capital Management.

"Historically, the third year of a first-term president is the year when markets perform best, as the administration knows a growing economy is the key to being re-elected. Stimulating the economy as much as possible in the pre-election year is a pattern that has repeated itself throughout history, and Obama's administration is likely to be no different."

Mr Cullen adds that the long-term outlook for US stock markets is encouraging. "US companies have more cash on their balance sheets than at any time in the last 50 years, and corporate profits are at an all-time high. We are seeing the strongest US earnings recovery in over 25 years."

In many respects, US company performance has become divorced from the economy.

One reason is that they have been desperately slashing costs and piling up cash surpluses to survive the downturn. This is bad news for job creation, but good news for company balance sheets.

The other reason is that the big US companies, such as Exxon Mobil, Coca-Cola, General Motors, Ford, Hewlett-Packard, Apple, Microsoft and many more are global enterprises, and neatly placed to cash in on rising consumer demand from vibrant emerging economies.

If you invest in major US companies, you aren't just investing in the US, says Richard Thompson, the director of UK-based investment capital raising service Spring Capital Partners.

"S&P 500 companies earn 40 per cent of their income from outside the US," he says. "If you invest in the US, you are investing in world-class companies whose performance doesn't entirely depend on the domestic market."

This allows you to tap into soaring emerging markets at relatively depressed US share prices, Mr Thompson says.

"After strong performance in 2010, many Chinese and Indian companies are now costly to buy. Because the US hasn't done so well, its markets offer better value for money. Better still, emerging markets are hungry for established western brands, so there is plenty of scope for growth."

The West still has to endure enormous economic pain to get over the financial crisis, Mr Thompson says, but arguably, the US is over the worst. "It feels like the US has hit the bottom, unlike the UK and Europe, which means the only way is up. QE2 has weakened the dollar, and this should be good for the economy."

But it isn't without its dangers. That horrendous deficit has to be tackled. And there is one asset class Mr Thompson definitely wouldn't invest in: US Treasuries, or government bonds.

"They currently offer horrendously low yields," he says. "That can only go one way. Bond prices will fall and yields will rise, especially if we get inflation."

Jo Roberts, co-director of investment and tax advisers Dubai-IFA.com, says there are plenty of attractive onshore and offshore mutual funds to choose from.

Her favourites include GAM North American Growth, Schroder US Mid-Cap, Threadneedle American Absolute Alpha, and Canada Life North American, which have all performed strongly in recent years. "The US economy is beginning to recover. Companies are increasing capital expenditure. Domestic consumption is slowly rising. Consumer confidence is beginning to pick up. All of this will help US stock markets, which I would expect to outperform the UK and Europe. The US should be a good place to invest over the next few years," Ms Roberts says.

The US may be a good place to invest for a year or two, but at some point the country has to face reality. That multitrillion-dollar debt isn't shrinking any time soon, and the country has little appetite for the brutal austerity measures currently being inflicted on the UK and parts of the eurozone in a bid to balance the books.

The dollar's status as the world's reserve currency has spared the US a sustained assault by the bond markets, but unless the country shows the will to tackle its massive budget imbalances and soaring federal debt, that could quickly change, says John Greenwood, the chief economist at Invesco, the Atlanta-based fund manager.

"The bond market vigilantes are unlikely to continue to grant the US exemption from the kind of fiscal discipline they have demanded elsewhere, and the administration may be forced to stabilise the debt-to-GDP ratio by 2015."

Even another bout of QE2 might not save the economy. Banks have used it to bolster their reserves rather and boost their lending, which is desperately needed to stimulate recovery.

"If households and companies continue to repay debt and banks remain risk averse, it is entirely possible the Fed's purchases will fail to have any effect on bank lending in 2011.

"This is exactly the problem that the Bank of Japan encountered when it pursued QE between 2001 and 2006," Mr Greenwood says.

In January, Bill Gross, manager of the world's largest US-based mutual fund, Pimco Total Return, issued a stark warning that "American politicians and citizens alike have no clear vision of the cost of a seemingly perpetual trillion-dollar annual deficit".

Unless the US curtails its "mindless deficit spending", it risks higher inflation, a weaker dollar and the eventual loss of its AAA sovereign credit rating.

Mr Gross recommends equity investors look to countries and currencies that appear to have their act under control, such as Canada, Brazil, and even Mexico, despite its drug-related violence.

This contradicts the positive spin offered by many investment analysts. They may be right, and stock markets will rattle along for a year or two, but at some point, the US will have to answer some hard questions. It has done this before, and shown remarkable powers of recovery. Can it do it again? The US is certainly on the brink, but whether this is of decline or recovery, nobody knows for sure.

 

pf@thenational.ae