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

  • The economic expansion is nearly ten years old and amongst the longest on record but there is plenty of life in the old boy yet. GDP rose by a stonking 4.2% in Q2; double that of the underwhelming first quarter. The economy is forecast to expand by 2.9% this year, the fastest pace of annual growth since 2005. Growth was powered by the sweeping new Trump tax cuts whilst there may also have been a rush by exporting companies to get their products quickly shipped overseas to avoid retaliatory trade tariffs. This quarter may prove to be the high point in the cycle, not least because global trade tariffs have now come into force. As for when recession will finally arrive, 2020 appears consensus thinking.
  • CPI inflation rose 2.7% in August, flirting with the highest level since 2012 as the job market gets ever tighter and oil prices remain firm. Wage growth remains a key economic indicator; should inflations pick up further then the Federal Reserve will be forced to accelerate the pace of interest rate rises, though for now it is continuing with the regular 0.25% increments. The Fed funds rate is currently at a 2.25% upper bound with another 0.25% rate rise likely this year and three more in 2019. By this point, probably late summer, the Fed Fund rate would be at 3.25% and the expectation would be that the economy would be cooling down, making this the terminal Fed Fund rate for the cycle. If this were not the case and more rate rises were needed then bond markets could become rather jittery.
  • Tightening is not just the Central Bank raising the base rate; it is also the Commercial Banks tightening their own credit controls. This hasn’t happened yet with the Banks enjoying strong revenue growth, improved balance sheets and low loan losses. However, post 2008 they are still risk adverse and our sense is that as the Fed continues to hike rates, the economy slows, and the yield curve continues to flatten then eventually the Banks will tighten their lending policies which in turn will take the tightening baton from the Fed who will at this point call a halt to their gently, gently rate rising policy. We suspect this will most likely take place around the middle of next year.
  • Second quarter earnings were again pretty ballistic rising by around 24%, the same rate of growth as Q1 and driven by the IT, energy (huge bounce in y/y oil price) and materials sectors. Whilst a portion of the earnings uplift can be attributed to the Trump tax cuts, US companies are also benefitting from strong domestic and global growth and, for the multinationals, the tailwind of a weak dollar in 2017. The second quarter will likely mark the high point of growth for this cycle though the forecast for the year as a whole is a whopping 20% earnings growth. The stronger dollar and Central Bank tightening are strengthening headwinds to growth and there will likely be a slowdown next year with the forecast for 2019 being a still impressive 10% earnings growth and 5% revenue growth.
  • The US mid-term elections take place on November 6th, the chance for a vote on the first half of the Trump presidency with all 435 seats up in the House of Representatives and 34 of the 100 seats in the Senate up for grabs. The Republicans currently hold a majority in both houses and while the mid-terms are traditionally ‘anti-incumbent’ it would be a shock if the Democrats took back one of the houses. The main interest is whether post-election Trump will ease back on his grandstanding policies, most notably playing hardball with trade tariffs.
  • It has been a difficult year for most global stock markets but no-one has bothered telling Wall Street which goes from strength to strength. The S&P has risen by 11% thus far in 2019, driven by the strong economy and the supercharged corporate earnings. Dating back to March 2009 this is now one of the longest bull runs in US stock market history and I expect we will hear the ‘tired’ and ‘over-extended’ argument more and more in the coming months. Market valuation is not cheap at 17x forward earnings but not in itself expensive enough to warrant a correction; the catalyst for the eventual fall will come from economic data or, increasingly likely, political bombshells either at home or abroad.

Summary. The economy remains in good shape and corporate earnings growth is forecast to be around 20% this year which mitigates some of the valuation concerns. Unlike the rest of the world Wall Street seems immune to worry, climbing steadily higher as other global markets stutter or fall. There are though some headwinds; Trump, trade tensions, rising Bond yields and the pace of Federal Reserve Bank interest rate rises.

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