In a world of low, low, low growth, the US stands out


By James Brooks

In today’s increasingly low growth global economic environment, the United States market will be the standout performer for investors in the short-to-medium term, according to two presenters, who spoke at the PortfolioConstruction Forum’s Markets Summit in Sydney on Tuesday.

“The US has reached a turning point as its economy moves beyond what the eurozone and Japan could ever dream of doing,” Lazard Asset Management managing director and portfolio manager Ron Temple said.

“As a result, the US is now enjoying strong labour growth and the benefits of an energy revolution that will allow it to pull even further ahead of the eurozone and Japan in the next three-to-five years ahead.

“Therefore, I recommend that investors allocate more of their capital to global equities, with US stocks featuring prominently within their portfolios,” he said.

While conceding that the US still faced the medium-term challenges of debt deleveraging, widening class inequality and the need for structural reforms, Temple highlighted the strong recovery in the North American labour market as a significant bright spot.

“The US job market has regained momentum beyond what I could have imagined last year,” he said.

“From November 2014 to January 2015, the US created one million new jobs - the last time the US created that many jobs in three months was in 1997.

“Adults are coming back into the labour force, because jobs are being created, but, on the upside, we’re still pretty far away from any wage pressure as between 2.4 and 4.9 million jobs need to be created for the US to reach full employment, which means there’s no reason for the US Federal Reserve to be aggressive in raising rates.

“Our analysis suggests the United States still has substantial excess labour supply, which should reduce the risk of meaningful labour inflation in the near term.

“In spite of this lack of pricing pressure, we worry that the US Federal Reserve might unintentionally aggravate the challenges facing the underemployed and weaken future economic growth by normalising monetary policy prematurely,” he said.

Energy revolution

Moving beyond jobs, Temple said the US was benefitting from an energy revolution that could see it surpass Saudi Arabia in oil and gas production, which will be a windfall for consumers.

“The average price of petrol in 2014 in the US was $3.36 a gallon, compared to $2.04 at end of January 2015, based on which the average American household will save $1,030 annually.

“To put this in perspective, if petrol prices were to stay where they are today, given the average US house hold income is $51,139, this represents a big increase in their potential disposable income, which in turn, based on our research, will lead to a bigger lift-off in consumer spending,” he said.

With this in mind, Temple strongly recommended that local investors ‘go global’ when seeking capital appreciation.

“In Australia, there’s always a home country bias, but please encourage your fund manager to give you more than just local banks and miners,” he said.

“It can be liberating to go global and invest in US equities, such as small caps that will appreciate in a low growth environment,” he said.

Focus on small caps

Echoing this viewpoint in a different presentation at the summit, Neuberger Berman multi-asset chief investment officer Erik Knutzen noted that US equities were benefitting from a combination of favourable tailwinds, with smaller stocks in particular now being poised to do better.

Knutzen observed that 2014 had witnessed the return of market volatility, low interest rates, low economic growth and low inflation, with the US economy receiving the only growth upgrade from the IMF to 3.5 per cent, which was higher than that projected for the global economy.

“Historically, ‘low, low, low’ has translated into a positive environment for risky assets, such as stocks and high yield bonds over traditional safer assets, such as government bonds,” Knutzen said.

“However, we think it is important to follow the earnings trail and, based on corporate earnings, the US stands out, and therefore I make the assertion that the US stock market and other investments are the best place to put your money on a 12-month cyclical basis,” he said.

Specifically, Neuberger Berman expected typical mid-cycle behaviour in the US, as growth should steady at around 2.5 - 3.0 per cent over the full year, with improving employment rates and rising wages supporting consumer confidence and resulting in stronger credit growth.

The corporate sector should also continue expanding at a healthy pace as capital spending and corporate activity are expected to rise.

Additionally, according to the asset manager’s research, as the unemployment rate and core inflation in the US move closer to the Federal Reserve’s targets, Neuberger Berman anticipated that the Federal Reserve should hike rates in mid-to late 2015, though they believe that rate hikes would be gradual as inflation remains fairly benign.

“Overall, business and manufacturing activity is very strong, with corporate earnings being the real story for the US, up 200 per cent since 2010, boosted by stock buybacks, which is a major tailwind for the market,” Knutzen said.

“Household net worth and consumer confidence are all-time highs and unemployment is down to historical averages of 5.8 per cent, which we believe will translate into wage increases this year and some incipient inflation.

“Placing all of this in a current context, in a low, low, low world, the economy that is less low, with stronger growth and rising interest rates and rising inflation is positioned to do well,” Knutzen said.

Neuberger Berman acknowledged that given the strong appreciation in the S&P 500 over the past few years, US equities appear to be trading closer to longer-term valuation levels and Knutzen encouraged Australian investors to consider the smaller cap US stocks on offer.

“We think the best way to play the US stock market is via the smaller companies stocks, as they are much more heavily geared to the local US economy, unlike their larger cap counterparts, which are facing headwinds due to a stronger dollar and weaker growth overseas, where they generate a large portion of their earnings.

“The US holds the cards at the moment and it is poised to do even better in the next 12 months, with increased merger and acquisition activity, increased investor activism and more corporate transactions all putting a continued bid under US small company stocks,” Knutzen said.

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