Investment Strategy:  Third Quarter – Specific Market Reviews: United States

  • Despite a prolonged government shutdown and fears over slowing global growth, the US economy beat first quarter growth expectations. The world’s largest economy expanded at an annual rate of 3.1% in the first three months of 2019, up from 2.2% in the previous quarter.
  • However, forecasters are starting to get the jitters somewhat and the bond markets are certainly predicting a sharp contraction in growth. As always, it will be a question of watching the data closely, most notably the ISM manufacturing index, currently at 50.1 from a peak of 60 last June and with a print of below 50 indicating a contraction in activity. There is plenty of uncertainty in trying to read the runes of the economic data;  manufacturing data and business investment is signalling slowdown, even recession, whereas consumer confidence, two-thirds of the economy after all, is feeling more confident is at its highest for 15 years despite a small drop in June. A conundrum.
  • The labour market remains tight with unemployment at its lowest since 1969 and wage growth at an annual rate of 3.2% which is well ahead of inflation which is running at 1.8%. A consequence is corporate earnings are coming under increasing pressure as they are struggling to pass increasing costs on to consumers. Earnings were flat in the first quarter despite revenue growth of 5% and are forecast to have fallen 2.6% in Q2, be flat again in Q3 but rise sharply to 7% in Q4 giving an annual gain in 2019 of around 3%. This is miserly, but remember that it is from a very high base after last year’s bumper 20% rise. My concern is that earnings forecasts typically move from North West to South East as the year progresses and I’m never keen on the ‘it’ll be alright on the night’ reliance on a bumper last quarter. I would not be surprised to see earnings flat for the year as a whole with the US  entering an earnings recession.
  • Jerome Powell, head honcho, at the US Federal Reserve has signalled a major shift in US monetary policy to a far more dovish tone. At the beginning of the year expectations were for  one more rate rise but now he has produced a major about turn and is clearly signalling a couple of rate cuts in the second half of the year and the Fed Funds rate could plummet back towards zero if the slowdown in US growth gains momentum. The bond market has taken this on board with 10 year Treasury yields falling sharply to 2% and the yield curve inverting, a much followed harbinger of recession. 
  • The equity market continued to rally strongly last quarter with the S&P 500 now having risen by a whopping 18% this year. The strong market means that valuations are no longer so supportive with the market trading on forward P/E of 16.5x, which is somewhere around historic averages, making it more vulnerable to negative news flow.

Summary. Equity markets continued to produce strong returns but a slowing economy, rapidly falling earnings estimates and a relatively rich valuation suggest little further upside and more volatility for the rest of the year.

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