Once Upon a Time in America
Are we about to enter a golden age? And if not, why not? Tell me if I’m wrong, but the US economy is no longer in ‘recovery’. It is alive and well and, quite literally, back at work. And when it’s not at work it’s at the shops.
The US has created 1.7 million net new jobs this year, most all of them in the private sector and many of them high quality roles in manufacturing. This month (September) will almost certainly mark the fourth year of month-on-month positive jobs growth. Retail sales, measured by value, are now well ahead of their pre-recession peak, up 15% according to Oxford Economics, with scarcely a hesitation the trough in June 2009.
Time to crank up interest rates? The Federal Reserve seems to think so. According to its latest ‘dot plot’ guidance, 14 of the 17 members of the rate-setting Federal Open Market Committee (FOMC) expect the upward cycle to start next year and to reach 3—4% at the next peak, probably in 2017. This is significantly lower than the peak in the previous cycle, when the Federal Funds Target Rate reached 5.25%. Given consumer inflation sitting at a fairly steady 2%, with the dollar rising and the oil price falling, there is no need to rush.
How are investors responding to this return of Goldilocks, an economy where growth is good and inflation low? Fairly well, we should say. The MSCI North America returned 36.5% in the two years to 25 September. But the past nine months (year-to-date) account for only 8% of that, while forward signals are decidedly mixed.
For most of the past 24 months, the ‘earnings trade’ has dominated US equities. As economic growth became embedded, investors focused on stock selection to search out pockets of superior earnings prospects. In aggregate, the flows tended toward small and mid-cap, technology and biotech. As money came in, upward momentum in the share price sped up, drawing in more money and stretching out valuations. Reckoning came in March—April this year with a sharp re-assertion of value and a parallel collapse in growth.
The sharpness of the rotation – worse than the 2011 Eurozone crisis – showed that the market’s low surface volatility covers an underlying dynamic that is far from calm. But in our view, overall volatility would need to be much higher to signal a secular change in the value/growth balance, and indeed, since mid-April growth has once again been dominant. The rotation has not ended growth momentum, but it has moderated risk appetite, with stocks showing strength at the balance sheet level being bought to hedge some of the higher growth stocks.
Economic growth, combined with low interest rates, should continue to support growth stocks and justify higher valuations. As ever, it is important to tread carefully and maintain diversity.
Important information: Past performance is no guarantee of future results. The value of an investment and the income from it can fall as well as rise and investors may not get back the amount originally invested. Old Mutual Global Investors (OMGI) has no house market view and opinions expressed are the views of individual fund manager(s) as at the time of writing. These views may no longer be current and may have already been acted upon. Any underlying research or analysis has been procured by OMGI for its own purposes and may have been acted on by OMGI or an associate for its or their own purposes. OMGI is the appointed investment adviser for Old Mutual Fund Manager’s in-house OEIC funds. Old Mutual Global Investors is the trading name of Old Mutual Global Investors (UK) Limited. Old Mutual Fund Managers Limited, 2 Lambeth Hill, London EC4V 4AD. Authorised and regulated by the Financial Conduct Authority. A member of the IMA. Old Mutual Global Investors (UK) Limited, 2 Lambeth Hill, London EC4P 4WR. Authorised and regulated by the Financial Conduct Authority. Telephone calls may be recorded for security purposes and to improve customer service.