Is US GDP running at over 4% encouraging or scary? On the one hand it seems that the engine of the world economy is in rude health; but it may also accelerate the pace of interest rate rises and hasten the next recession. Should the US market be avoided?
- The concern is that the economy will over-heat, prompting higher-than-expected interest rate rises
- US companies continue to deliver on earnings
- Unusually, passive funds may not be the right option at this point in the cycle
In many ways, this is little different to the dilemma that has faced US investors for some time: does the faster pace of economic growth justify the higher valuations commanded by US stocks?
The concern is that the economy will over-heat. The aggressive stimulus packages put in place by President Trump are highly unusual at this stage of the cycle. The labour market is already tight and the fear is that wage growth will accelerate. Although core inflation has remained at or near the Federal Reserve’s 2% target, it could spike higher from here.
A September rate hike is now 80% priced in by the market, but it may still be underestimating the number of hikes in 2019. This assumes a normal growth scenario. This would have to change if the economy started to show clear signs of over-heating. Of course, there are risks on the opposite side as well. The trade war may hit the US last, but that doesn’t mean its impact won’t be felt.
The question is whether it is a reason to move into US assets, which are still expensive by all normal measures. Certainly, US corporates continue to deliver strong earnings. In this latest earnings season, 90% of the companies that have reported so far outstripped expectations. NN Investment Partners said earnings grew by 25% and beat expectations on average by 5.2%. This is in notable contrast to Europe, where only 44% of companies have beat their earnings estimates so far.
The trouble with the US market is that many investors use trackers to access it. This is understandable – active managers have often failed to keep pace with the market – but there have been some important missed expectations among the largest and most expensive companies – Facebook and Netflix for example. Although there are only pockets of weakness, this has a disproportionate effect on investor returns.
There are many who believe that the US market has further to run and is the best place to be if global growth momentum is weakening. 4%+ growth does look scary but may over-estimate the real pace of the US economy. At the same time, many will conclude that they should just keep dancing while the music is still playing.