The most reliable source of demand
The strong third quarter growth in US GDP announced last Thursday - a 3.5% annualised rate - not only suggested that the American economy is on a sustainable upward trajectory; it also confirmed that the Federal Reserve’s decision to end quantitative easing is appropriate. Although the faster-thanexpected headline growth figure was partly driven by government spending, the two key engines of the economy - business capital spending and personal consumption - both turned in a respectable performance.
What’s more, the outlook remains bright. Low US bond yields - depressed in part because of worries over Europe - translate into a low cost of capital for US corporations, which should encourage businesses to borrow to fund capital spending. The demand is there; capacity utilisation in the US is tight, and outside the energy sector we are beginning to see pick-up in corporate sales, which normally lead business capital spending by around three months.
Low yields have also kept mortgage rates down, which has helped to improve the affordability of housing. Factor in the stimulative effect of lower energy prices on consumers, and it is small wonder that the Conference Board index of US consumer confidence climbed to a 7-year high in October. Taken together, all these positive factors suggest an emergence of the US “triple merit scenario”.
Granted, not everything in the garden is rosy. Brighter economic prospects and rising expectations of interest rate hikes next year will push the US dollar higher, especially with Japan stepping up its own QE programme and with growth elsewhere in the world remaining weak. That’s bad news for US multinationals, which are already seeing the dollar value of their international earnings eroded by the US currency’s strength. In his third quarter earnings conference call, IBM’s chief financial officer complained that the appreciation of the US dollar is hurting the company’s business. Other corporate giants, including Coca-Cola, McDonald’s and Johnson & Johnson, are facing the same problem. This is a marked reversal compared with much of the last ten years, when US dollar weakness boosted the value of their overseas earnings. In contrast, domestically focused companies with little by way of foreign currency earnings (and few foreign competitors) are largely immune to the US dollar’s strength.
As a result, although we are positive on the US, buying into the broad equity index, which consists of both multinational and domestic companies, may not be the best choice.