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Market views - USA

March 2010

We are at a fascinating juncture for the US with continued evidence in support of recovery. Our favoured indicator, the ISM Index of manufacturing conditions remains comfortably above the boom bust line (of 50) at 56.5 in the latest release. This is a level consistent, ordinarily, with very strong overall growth. Industrial production is improving and capacity utilisation is finally lifting from very depressed levels. So, is this the start of sustained recovery?  Is the world normal again as many would have you believe?

Our view is that it remains too early to make these calls. Of course we still have very low interest rates and highly stimulative fiscal policy which are boosting activity. But, behind the relatively benign picture remain many of the same difficulties that got us into this mess in the first place. There is still too much debt in the system both at the consumer level and increasingly by Governments both in the US and elsewhere. This means that the process of tightening fiscal policy and raising interest rates is likely to be a real tightrope walk for the authorities with dangerous fiscal deterioration or stalling growth the price of getting it wrong.

The indicator we are most avidly watching is the labour market. It is clearly less problematic than it was but can be characterised by getting worse at a slower rate rather than actually improving. Unless jobs are created in significant numbers it is hard to foresee a self sustaining recovery in consumption taking place any time soon. Job creation does somewhat lag growth but we have several areas of concern. It seems to us that it is getting more expensive to hire in the US with higher taxes and, now, increased healthcare costs for employers. Companies can easily relocate to cheaper parts of the world with the obvious impact on jobs domestically. Two notably large companies have been making comments recently to this effect so it seems a real risk that increasingly jobs will be hard to come by. Japan may be a good example here where over many years the positions offered have become lower paid and often temporary in nature. Hardly supportive of recovery.

Turning to the markets, the last twelve months have brought a dramatic recovery albeit from a very depressed level. With policy levers (interest rates and fiscal policy) fully engaged most economic indicators have improved, a financial meltdown has been avoided and in turn corporate earnings have rebounded strongly. These factors easily justify the large moves witnessed. But where to now? Our view is that the easy money has been made and a more balanced approach is warranted. Despite a decent cyclical recovery in the macro economy the structural issues of too much debt still give us cause for concern. If any evidence emerges to suggest that growth is moderating then, in turn, this is likely to unsettle markets and lead to some risk of declines in the markets. We see significant downside as unlikely right now but stress that indicators need to be watched very carefully.

Our central case, this year, is for more volatility in the summer months as the durability of recovery is questioned followed by a potential rebound later on in the year. Typically stock market returns in the year after the recession ends are moderate and generally mid single digit percentages. An outcome we see as quite likely. A nimble and flexible attitude in these difficult times is likely to continue to be the right strategy.

Page last updated April, 2010 ID1719