US economy closes the year on a firm footing

By ERIC STURDZA

Monthly Fund Commentary
19 Jan 2017

By ERIC STURDZA

In December, the US economy closed the year on a firm footing as the household sector seemed to be in good form, the labour market appeared to be solid, post-election optimism was elevated (and may very well contribute to an increase in business fixed investment), and the global outlook seemed to be rosier (although challenges remain).

Even though Republicans now control the White House and Congress, which should make it easier to get things done, there remains a significant hurdle to clear in terms of possible conflict between the incoming administration and the Republicans in Congress, as transitions are usually bumpy. Furthermore, monetary policy will remain data dependent as expectations for a larger federal budget deficit have pushed long-term interest rates higher, but low rates abroad are expected to prevent U.S. bond yields from rising abruptly. As such, equity investors shifted their attention to the next two years and what the actual impact of a possible fiscal stimulus will be.

The Investment Adviser remains confident on the general outlook for the US economy but will be closely monitoring the following themes amongst others:

(1) Consumer spending: The greatest hurdle when looking forward remains the job market’s health. If the market is close to full employment, not only would the economy see a rise in wage growth and consumer spending, but also fiscal stimulus would be more likely to yield higher inflation. Normally, a tight job market (where there is no slack remaining) reveals itself through stronger wage growth but for the moment, many metrics such as the number of people working part-time but actually want to work full time, suggest that there still is some spare capacity. The average hourly earnings trend is slightly higher on a three-month basis but is also pointing to a job market that still has room to grow. Also, as the benefit of lower gasoline prices fades, the growth of inflationadjusted wages is slowing. This is of importance because consumer spending accounts for nearly 70% of GDP and as long as we don’t see strong wage growth, which would in turn push consumer spending higher, the upside for GDP growth remains limited.

(2) The housing market recovery: The incoming administration should be able to find common ground on tax cuts. The consensus is we will see a package by the middle of 2017. However, for the household sector most tax cuts seem to be oriented toward the 1st quartile of the income hierarchy where they are more likely to be saved than spent. Nonetheless, if we look back at the Bush administration and the tax cuts that were implemented then, there is a possibility that upper income households will take some of the tax cut and spend it on buying second homes which would boost the housing recovery that has been slower than initially anticipated.

(3) Energy and business fixed investment: The energy sector remains important for the US economy. The energy contraction has been a headwind for business fixed investment as oil and gas well drilling is capital intensive and capital investment has sharply declined since 2014. The headwind seems to be abating and even though a sharp rebound seems unlikely, related capital spending will no longer be such a drag on business fixed investment and on overall GDP growth. Additionally, business tax cuts will inject more cash into corporate balance sheets, which could also spur increased activity (even though firms have already enjoyed easy access to credit).

(4) The global outlook: The global economic outlook looks better in the near term but some major challenges remain. The consequences of Brexit are still to come as a two-year negotiation process is set to start in March. China’s economic transition will most likely remain bumpy and the US dollar, which has strengthened since the election, will contribute to a larger trade deficit (although as in 2015, the impact on real trade activity might not be as severe as anticipated).

Even though these are just some of the major highlights and hurdles to monitor going forward, the Investment Adviser remains confident in the Fund’s strategy (of selecting companies that have, and are still, positioned to deliver consistent robust growth) and its strong potential for returning both relative and absolute value to shareholders no matter the direction in which the US economy unfolds. In other words, even if the economy grows at a slower or faster pace than expected, investors in both cases will end up favouring companies that are cheap and offer above average market earnings growth which, over sufficient time periods, has always resulted in share price appreciation. More details will be available as the new administration enters into office, but the Investment Adviser is optimistic on the potential positive impact it could have on the economy and its growth outlook.

 

The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 16/01/2017 and are based on internal research and modelling.