United States

30 Oct 2019

Investors in Wall Street are torn between their appreciation of the continuing growth of the US economy and the political clouds surrounding Mr Trump.  Much has been made of the fact that this economic cycle is now the longest on record, surpassing the previous stretch between 1991 and 2001; the new high was set when data for Q2 revealed another positive outcome for growth though at a materially slower pace than in the first quarter of the year. 

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While the persistence of this growth has helped to underpin the current bull market for equities, the gradient of this recovery is one of the shallowest on record, certainly in the post-war era.  The current expansion phase, which now stands at 45 quarters, has produced annual growth of a mere 2%, whereas previous cycles have frequently reflected 4% or more and the past ten have averaged well above 3%.  One factor behind this more sluggish rate of progress is that the household sector has been steadily reducing its level of debt.
 
As the chart below illustrates, household borrowing as a percentage of national income rose steeply during the 15yrs that preceded the financial crisis from 60% to 97% and, in the fifty or so years prior to 2010, barely ever registered a decline.  However since this present economic recovery began, consumers have worked hard to repair their individual balance sheets, taking this measure back down to below 75%.  Their increased savings and lower readiness to utilise credit facilities have been two of the principal factors behind the lacklustre pace of growth in the current economic cycle and consensus forecasts for the next few quarters are for the growth rate to slow even further.  
US debt as % of GDP

US debt as % of GDP

Source: Refinitiv Datastream, Schroders Economics Group. 24 September 2019

Encouragingly for both economic growth prospects and consumer confidence levels, unemployment has persisted at almost 50yr lows and the fall in US Treasury yields mentioned earlier has lowered the cost of mortgages.  This combination should prompt a rebound in the housing market and new building permits have more than recovered the dip in activity which occurred last year.
 
Mr Trump’s increased use and amount of tariffs is boosting the level of inflation in the near term: core inflation (which excludes the impact of both energy and food prices) is running slightly above the target of the Federal Reserve (Fed).  Nevertheless the deflator measure used by the Fed as its preferred indicator remains comfortably below the 2% level and this has allowed Mr Powell as Fed Chairman to unveil its second interest rate reduction.  
Members of the Fed Committee appear to be very divided on the future path of interest rates over the next year
Part of the Fed’s justification will also be the level of international tension around tariffs and global free trade and it will be keen to offset, if it can, any increase in economic uncertainty that stems from presidential actions.  However the members of the Fed Committee appear to be very divided on the future path of interest rates over the next year, as demonstrated by the release of the “dot plots” data – these reflect the views of the 17 individual members and show that eight members predict lower rates in a year’s time but seven others forecast rates to be higher.
 
The President in recent weeks has expanded the level of tariffs with increased amounts levied on a wide range of Chinese goods while also including a number of European items in his basket and even targeting India in his rhetoric over their existing levels of tariffs imposed on imports.  While that will have raised tempers across international boundaries, Washington too has experienced inflamed emotions as the Democrats sought to begin the process of impeachment as it became apparent to them that the President had reportedly threatened to withhold US aid from Ukraine if they didn’t launch an investigation into the affairs of the Biden family (Joe Biden being a front runner to be the Democratic nomination for next year’s Presidential Election).
 
Wall Street has continued to be the beacon for global equities and notched up another positive quarter, though of lesser scale than either of the preceding quarterly periods.  Gains emerged at less than 2%, but were still achieved against a backdrop of falling analyst estimates for corporate profits in 2019.   From the rosy height of 9-10% growth that reflected consensus estimates back at the start of this calendar year, the current expectation is for around 2-3%. 
 
That 7% reduction in profit forecasts should be seen in the context of a gain of almost 20% in US share prices in the same period, leaving the index on a relatively demanding rating of close to 19X expected net profits.  The principal factor restraining investors from reducing exposure to such an expensive market is the shortage of growth opportunities elsewhere and the prevalence of many US quality multinationals in the universe of growing companies, most obviously in the technology sector.

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