We’re baaaack! American economy shows ability to renew itself

Cheap energy, an improving economy and attractive valuations make a compelling case for American stocks.

So said Cormac Weldon, Head of US Equities for Threadneedle Investments while in a general discussion about why the United States’ ability to bounce back from economic setbacks is placing US equities firmly on the investment agenda.

“The American economy is once again demonstrating its ability to renew itself and is emerging from the credit crunch with a new technological revolution underway. Meanwhile, consumers are reducing their debt and corporate America is cash rich. Perhaps we shouldn’t be surprised at this turnaround because America has consistently bounced back from previous setbacks. This resilience has been underpinned by factors such as strong population and immigration growth, the mobility of its workforce and a robust productivity culture,” said Mr Weldon.

He went on to say that three key themes emerging from the US indicate that the economy is on the move – leading Threadneedle analysts to consider US equities well placed to deliver healthy returns to investors.

These three themes are:

• Cheap energy is driving economic growth. The shale energy revolution means that, unlike other industrial economies, the US now has increasing access to cheap oil and gas, which has the potential to drive industrial and employment growth for years.
• Dynamic labour markets are supporting industrial revival. Improving labour market conditions are being driven by a flexible labour force, and nowhere is this better demonstrated than in the automobile sector. Not so long ago the survival of GM and Chrysler was in doubt, yet today the big three Detroit automakers are reporting significant profits on the back of rationalised production, reduced capacity and lower labour costs.
• The banking sector is returning to health and the housing market is stabilising. Domestic banks have recapitalised, and while loan growth remains weak, the expectation is that it will pick up. Currently, while house prices are very affordable and mortgages are cheap, new household formation remains low. However this should change as new jobs are generated, people feel more secure about their employment prospects and the become increasingly confident that the homes they plan to buy will not fall in value.

These themes all paint an encouraging view of the US economy, but Mr Weldon acknowledged that strong economic data isn’t the only factor to consider.

“Of course, a strong economy alone doesn’t always translate into rising share prices. But we are confident that US equities can deliver healthy returns to investors. The free cash flow yield of the US equity market compared to the yield provided by the US corporate bond market reveals that equities are at their cheapest level in more than 50 years. In addition, our bottom-up research has identified a number of very attractively-valued companies with excellent growth potential. Our focus is on companies exposed to faster-growing industries emerging from cyclical lows, and innovative growth companies with strong business models.”

Mr Weldon concluded by saying that, while the future for US equities looks rosy, challenges do remain.

“The Eurozone is top of mind given its uncertain political, fiscal and monetary situation,” he said.

“The possibility of an administration change in the US also has the markets concerned, in particular in relation to how the big issues of deficits and tax cuts might be addressed come November.

“Nonetheless, we firmly believe that US equities can make further progress this year. Positive factors include: continuing earnings growth in the mid-single digit range and the likelihood that profit margins will be stable; as well as the robust health of the corporate sector. In addition M&A activity has started to pick up and the valuation of the market is undemanding. For investors, now is the time to consider allocating to the US.”

26 July 2012