• The US economy is yet again reinventing itself. This has been helped along by a determination to get the US economy moving again after the global financial crisis but the real drivers are an energy boom, a manufacturing renaissance and American innovation.
• Together these drivers could add as much as 0.5% to annual US economic growth in the decade ahead.
• For investors, while a return to the sustained double digit share market returns seen through the 1980s and 1990s is unlikely, the turn for the better in the US is likely driving a new secular bull market in traditional global shares.

Introduction

Economic growth a strong possibility for the US.

The problems with the US economy are well known. Its level of public debt is too high, its spending on social security and health is unsustainable, its health system is woefully inefficient – spending more relative to GDP than most OECD countries but with worse life expectancy – its level of savings is too low, its transport infrastructure is becoming run down, its political system seems dominated by ideology and its share market has had a rough time over the last 14 years as the tech and housing credit booms burst.

But it is dangerous to write the US off. Every two or three decades it seems to reinvent itself. It did it with electricity and mass production in the 1920s, with consumerism, petrochemicals and aviation in the 1950s and 1960s and with deregulation and the IT revolution in the 1980s and 1990s.

Don’t write the US off

The US was written off by many during the 1930s only to see it emerge as the world’s major super power and strongest economy in the post war years. The same occurred in the 1970s after the debacles of the Vietnam War, Watergate and stagflation only to see it reinvigorated by Ronald Reagan. Both the 1950s-1960s and the 1980s-1990s saw strong returns from the US share market.

After the debacle of the tech wreck and credit bust of last decade and the loss of its AAA credit rating by S&P, amidst dysfunctional politics, many have been tempted yet again to write the US off. But once more it seems to be bouncing back. This time around the drivers include: American policy makers’ determination to fix their problems; an energy boom; a manufacturing renaissance; and ongoing innovation.

The Fed and the shrinking US budget deficit

American policy makers are criticised a lot, eg for first undertaking quantitative easing and now for slowing it! But they do show a determination to fix things up once they go wrong and for moving a lot faster than other countries. This has been evident since the GFC with the Federal Reserve trying one approach after another to stabilise and then get the US economy moving again and the forced recapitalisation of US banks, which helped restore confidence. That these policies are working is evident in the Fed now moving to slow down its quantitative easing program, effectively taking the US off life support as it appears to be getting to the point where it no longer needs it.

But perhaps the big surprise for many is the massive slump in the US budget deficit over the last few years, which basically explains why you don’t hear much about it these days. As can be seen in the next chart the US Federal budget deficit has shrunk from more than 10% of GDP In 2009 to less than 3% of GDP this year. This reflects a combination of stagnant government spending over the last few years and surging revenue growth.

It is expected to start rising again beyond 2015 to around 4% of GDP by 2022 (according to the Congressional Budget Office) as an aging population really starts to boost spending on social security and health, so there is still more to do. But the savings from the 2011 debt agreement, the scaled back “fiscal cliff” and the “sequester” spending cuts add up to almost $US4 trillion over 10 years and should not be ignored. It’s a long way from the fiscal mess of a few years ago.

The energy boom

It seems only yesterday that the “peak oil” fanatics were raving on (yet again) about how global oil production would soon peak and we would have to ditch the car and return to the horse and buggy. It was nonsense then and even more so now. The basic thing they missed is that rising oil prices will both lead to more fuel efficiencies (just look at all the hybrid cars now available) and make economic access to new supplies of energy viable. This is happening in the US with a vengeance as fracking technology – drilling down and then sideways into shale beds and then pumping in a mix of water and chemicals to fracture the rock allowing gas and oil to be extracted – is leading to a massive energy production boom. US oil production is up around 45% over the last five years which has taken it back to 1990s levels and total energy production including gas is back to late 1980s levels. See the next chart. By around 2020, US oil production is likely to have returned to 1970 levels and the US will be back to being the world’s biggest oil producer.

The energy boom is providing a huge boost to the US economy by boosting demand for drilling services and infrastructure, lowering energy costs & reducing the US trade deficit. US oil is trading around $US7 a barrel below global prices and US natural gas prices are tending to run around one third below European levels and one fifth of Japanese levels. Rough estimates put the boost to US economic growth from the energy boom at 0.2% per annum. The decline in US oil imports can be seen in the next chart. This also means less dependence on the volatile Middle East.

The manufacturing renaissance

Numerous companies have announced that they plan to expand manufacturing production capacity in the US. This ranges from a plant to build a Honda super car to Apple bringing some component manufacturing home. The drivers have been a combination of:

• lower energy costs as cheap gas has seen electricity suppliers switch to gas, depressing the price of electricity;
• very low unit labour costs – as solid productivity growth and low wages growth have seen unit labour costs for manufacturers remain around 1980 levels; and
• the low $US after a decade long decline, which is still down 30% or so from 2001/2002 levels.

As yet this has only resulted in a tentative rise in manufacturing production relative to overall GDP, but it is likely to improve further as the manufacturing base starts to expand again. Very different to Australia, but then again we have seen a doubling in the value of the $A over the last decade, somewhat higher wages growth and surging electricity prices…but that’s a different story!

American ingenuity

Finally, underpinning all of this is American ingenuity and an economic system that encourages it and provides it with finance. The bulk of the new gadgets we get are developed in the US, it remains at the forefront of the IT revolution and its companies are world beaters. Since 1975, the Eurozone has given rise to just one of the firms to join the world’s top 500 companies, whereas 26 of them came from the US.

What does it mean for investors?

The key message is that the US is getting back in business (putting aside the winter freeze) with a potential to grow maybe as much as 0.5% pa more over the medium term compared to what otherwise would have been the case. There are several implications for investors. First, a stronger US economy is good for the global economy and supports the view that global share markets have entered a new secular (or longer term) bull market. Consistent with this, US shares have broken out to a new record high – both in terms of the S&P 500 price index and in terms of real returns after spinning their wheels since March 2000. See the next chart.

Second, the US looking stronger at a time when several emerging countries have hit a more difficult patch favours traditional global shares over emerging market shares.

Finally, whilst US and hence global shares appear to have entered a new secular bull market, returns are likely to be more constrained than was the case during the last secular bull market that started in 1982. This is because starting point valuations for shares are not as attractive as in 1982 and the boost from falling inflation and interest rates won’t be repeated again in the years ahead as inflation is already low.

By Dr Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital

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Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

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Mark Burgess

Threadneedle Investments has raised its 2014 GDP forecast for developed economies as a result of the strengthening global economic recovery.

The company’s US forecast has increased from 2.5% to 2.7% and its UK forecast from 2.25% to 2.5%. The euro area has seen the biggest jump from 0.7% to 1.1%.

Mark Burgess, CIO at Threadneedle Investments, said: “The global economic recovery is gathering pace. It is driven by the developed world and as a result we have raised our economic growth forecasts for the three major economies. The US is increasingly becoming an attractive base for manufacturing, while housing and consumption remain strong. The UK housing market has also strengthened, with notable improvements outside the buoyant London. The unemployment rate has fallen materially and consumption shows increased confidence. In addition, we have increased our euro area forecast, reflecting healthy growth in Germany and a better than previously expected recovery in Spain and Ireland.

“However, the better the developed economies seem to be doing, the more the discrepancy with the emerging markets becomes apparent. Volatility is likely to persist in the short term as emerging markets find increasing challenges to growth.

“Tapering of quantitative easing is leading to capital outflows from the region, putting a strain on currencies, especially in those economies with weak balance of payments. Consequently, we are seeing a number of interest rate rises to defend currencies which, in turn, will hit economic activity. China’s economy is proving slow to reposition away from investment towards consumption. An extended banking sector and fears of cracks in the shadow banking system are additional worries.

“It is important to note, however, that we do not expect these issues to become another contagious crisis. More emerging countries have floating currencies and higher currency reserves than in previous periods of crisis. The rapid currency devaluations and interest rate rises are already leading to the necessary adjustment of cutting consumption. China does not have a freely floating currency but it is not reliant on foreign capital and has some policy flexibility to help in managing its problems.

“We therefore see the current emerging market weakness as a correction, after a strong rally, which could offer an opportunity to add to equity positions. We prefer exporters over domestic consumption stocks. Outside this, our portfolio themes are little changed, searching for strong, growing companies, payers of good and increasing dividends, M&A beneficiaries and companies well-positioned for the global economic recovery.”

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US Monetary Policy; Population; Employment by industry

• ¾ US Monetary Policy: Federal Reserve chairman Ben Bernanke has signalled a new phase for the US economy. But bond buying (printing cash) won’t end any time soon.
• ¾ Population: Australia’s population grew by 1.75 per cent over the year to December – the fastest rate in three years.
• ¾ Industry employment: Employment rose by just 400 people in the three months to May after gaining 104,900 in the previous three months – the biggest quarterly gain in five years. Strongest sector in the May quarter was Retail trade (up 34,200) while Wholesale trade jobs fell by 32,000.
• ¾ Chinese economy: The ‘flash’ Purchasing Managers index in china for June was at a 9-month low of 48.3, down from 49.2 in May.

What do the figures show?

US Monetary Policy

• The Federal Reserve will continue to purchase debt at the rate of $85 billion a month and leave the official interest rate between zero and 0.25 per cent. But while the Fed chief Ben Bernanke hinted at an end to bond buying, he noted: “If you draw the conclusion that I’ve just said that our purchases will end in the middle of next year, you’ve drawn the wrong conclusion, because our purchases are tied to what happens in the economy.”

Demographic Statistics

Employment to May 2013

• Australia’s population grew by 1.75 per cent over the year to December – the fastest rate in three years. Australia’s population stood at 22,906,352 people at the end of December, but six months later the figure is most likely around 23.1 million.
• A record 305,400 babies were born over 2012, up 2.2 per cent over the year but deaths barely moved over the year to 147,000. Overseas migration totalled 235,900 in the 2012 calendar year, the biggest annual total in three years, but below the record high of 315,700 in the year to December 2008.
• Across the states and territories, fastest annual population growth occurred in Western Australia (3.47 per cent – fastest on record), followed by ACT (2.30 per cent), Queensland (2.05 per cent), Northern Territory (1.79 per cent), Victoria (1.78 per cent), NSW (1.25 per cent), South Australia (0.95 per cent) and Tasmania (0.08 per cent).

Employment by Industry

• Employment rose in 9 of the 19 industry sectors in the three months to May. Employment fell most in Wholesale Trade (down 32,000) after rising by 39,300 in the previous quarter. Next biggest fall was by Construction (down 20,300) followed by Transport, Postal and Warehousing (down 19,800). Biggest gain in
  

  Record Population WA May 2013

  jobs occurred in Retail Trade (up 34,200) followed by Public Administration and Safety (up 14,000) and Arts and Recreation Services (up 13,700).

• Healthcare remains the biggest employer with 1.40 million employees (12.1 per cent of the total) followed by Retail Trade (10.8 per cent) and Construction (8.6 per cent).

What is the importance of the economic data?

• Demographic Statistics are issued by the Bureau of Statistics each quarter. The figures include estimates of births, deaths, in-bound and out-bound migration movements and estimates of population change by State.
• The Australian Bureau of Statistics (ABS) provides detailed labour market figures
  

  Revised population data May 2013

  one week after releasing ‘top level’ statistics of employment & unemployment levels across states and territories. The detailed data is useful in identifying broader underlying trends and instructive about the health of the economy.

What does it all mean?

• Financial markets have over-reacted to the latest Fed decision. Rather than celebrating the fact that the US economy is starting to stand on its own two feet, investors are fretting about the end to cheap cash. The Dow Jones fell 206 points and the Aussie slumped against a stronger greenback to US93 cents.
• This is very much a knee-jerk reaction. The good news outweighs the bad.
  

  Baby boom May 2013

  And all the US economic problems haven’t been solved overnight. We are still tipping the Aussie dollar at US95c at end year and All Ordinaries at 5,200 points.

• Investors are also over-reacting to the Chinese PMI. The so-called ‘flash’ manufacturing gauge doesn’t line up well to the ‘official’ gauge of manufacturing activity. But if the Chinese economy requires stimulus, authorities are well placed to provide it with inflation controlled.
• Provided state and local governments respond to solid population growth then it represents good momentum for economies. That is happening. Businesses are in business because they want to grow and solid population growth assists in that growth.
• The job market is effectively flat-lining until the election is out of the way. The lift in retail jobs is clearly a big surprise.

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