Contrary to the excitement and intrigue I was able to report following my trips to the US over the last few years, this time all I can say is that everything appears ‘dead calm’ across the Atlantic.
For those of us of a contrarian bias, opportunities are scarce – and it seems set to stay that way.
At the headline level, the US economy continues to grow at a moderate and steady pace, despite the weather distortions earlier this year.
So was the weather as bad as has been suggested? Going on the haunted looks of the residents of the East Coast and the winter-scarred roads then I would say yes. Companies surely have an excuse to release damaged results for Q1.
But will the dawn of spring herald a shift higher in the US economy, which is what the consensus expects?
Possibly, but any pent-up demand should be transitory, and my impression is the circa 3% growth expected for the full year is too high. From what I heard, US growth seems much more likely to be circa 2-2.5%. In reality, that level would be close to the US economy’s long-term potential growth rate.
The major reason for the continuation of lacklustre growth is that the channels of credit in the economy remain clogged. Banks are taking a more constructive view to loans, but credit creation remains uninspiring.
At the same time, the companies that are hoarding ever greater amounts of cash are still reticent to ramp-up investment in their operations and most debt raised in the credit markets is going towards refinancing and balance sheet strengthening, rather than investment.
There are examples of funding being secured for M&A and dividends, but it is not enough to get spirits surging. There will be another gentle improvement in US capital expenditure this year, but none of the macro, bond or equity investors I saw believe it will be Boomtown, USA.
There is also scant evidence of companies starting to boost employees’ salaries. Wage inflation remains subdued, outside certain specialist sectors such as construction. Some surveys hint at better paydays to come, but most evidence suggests that while there is considerable slack in the labour market, there is little hope of higher wages.
This suggests the current low inflation environment in the US will persist (nobody mentioned inflation without my prompting on the entire visit).
Rates unlikely to rise
So if they are right and inflationary pressures are contained, it would surely give credence to the view that US rates are unlikely to rise in the next 12 months and indeed not at all in 2015.
The only thing likely to force the Fed to hike rates next year would be if any economic improvement was finally accompanied by rising wages, one of the Fed’s chief focuses in its refreshed ‘qualitative’ review.
Even if that happens, everything we have heard from Fed chair Janet Yellen in recent weeks implies a shallow progression in rate increases after the first hike.
The other major reason for rate rises to be delayed further than expected is that the Fed recognises the need for looser policy to help engineer an ongoing housing recovery. There has been a rebound, but prices in many states are still a long way from their 2006 peaks, especially on an inflation-adjusted basis.
The Fed sees rising house prices as the most efficient way to boost consumer spending and allow the wider populous to enjoy the fruits of their labours, in the same way the rich have through stock prices.
My expectation is that housing prices should recover by around 8-10% this year, a decent rate but below the stronger gains of last year. This will help consumer confidence and spending to recover at a modest pace. So what does that mean for asset markets?
I focused chiefly on opportunities in fixed interest and it is clear we are coming towards the end of the greatest credit rally in the history of financial markets.
We should ensure clients’ expectations are contained. With yields incredibly low by historical standards and spreads tight, we have to rein in our forecasts for credit returns in the coming years. However, the default outlook remains low and we should be comfortable we can clip coupons from our existing holdings.
The greatest risk appears to be from rising interest rates and Treasury yields. However, we believe this threat is not excessive for the remainder of 2014. There is increasing complacency in credit markets, mostly driven by investors’ demand for yield, but I do not see this as a threat this year.
In short, be willing to accept credit risk, but look to restrict interest rate risk. Our positioning with mostly high-yielding, short duration funds therefore seems sensible.
We have been structurally underweight US equities for the last year and we will remain that way.
Evidence from companies (admittedly distorted by the effects of a dreadful winter) is that profit growth this year should be close to the range expected by analysts – namely high single digits percentage growth.
Such an outcome, while far from certain, seems sufficient to justify current equity valuations mostly, especially given that interest rates, inflation and other asset classes’ yields remain so low.
But with US equity valuations rich by historical comparison, any disappointment will be punished. However, I don’t see any reason why, based upon our economic forecasts, US equities cannot return circa 6% annualised over the next few years.
However, we feel there are better opportunities in Asia, Japan and selected European markets.