The US economy is pausing for breath. Commentators on both sides of the Atlantic have been trying to second-guess the economic situation in the US for some time. Will there be a second wind? The economy seems to be growing steadily but investors should not be lulled into a false sense of security.
The market was caught by surprise when the pace of US GDP growth in the first quarter was the weakest in more than four years. Unfortunately, inflation was still too high for the Fed to cut short-term rates. Consumers made a counter-attack by increasing spending by 1.4 per cent in May – the biggest rise in 16 months. Optimism on the employment front and stockmarket gains helped offset other concerns. The pessimists simply scratched their heads but for how much longer can this situation continue?
We think the state of the US economy is favourable and we are probably in a mid-cycle pause. Imports have risen, inventories have been drawn down and the housing market has weakened further but the US has had a solid wage environment and strong stockmarket performance which has helped support consumer spending. On the corporate side, business investment is also supportive.
The consumer has been a resilient backbone to economic growth in the current cycle. There was a fear that falling house prices would hit spending hard and then fears that sub-prime weakness would do the same. As yet, this has not been the case. Likewise, higher food and energy prices have not put much of a dent in spending patterns. Americans have adapted to $60-plus crude oil prices.
These negatives are being offset by the strength of the employment market and the subsequent income gains. Nevertheless, investors should tread carefully in this area. Spending has so far been resilient but a day will come when Americans have to tighten their belts. After all, petrol prices are very high, even if they are slightly below their level a year ago.
Inflation is appearing in other areas, including most recently wages. Long-term borrowing rates have crept up, which will heap pressure on mortgage costs and could lead to an increase in the savings rate and a reduction in spending. The already fragile housing market could also be weakened further.
The weakness of the dollar is helping US companies with non-dollar earnings and giving them a nice windfall profit. We can find a large and growing number of companies that have a substantial proportion of overall earnings coming from overseas operations.
The strength of European, Asian and emerging market economies is alleviating some of the pressure from the potentially slowing domestic economy. Industry-leading companies that have achieved market dominance in the US are now growing market share abroad.
Even given the expected economic slowdown, we can still identify companies in a wide range of industries that should see continued strong demand at a stock level. Government spending should provide support as the tailwind from consumer spending diminishes. We would also expect companies to continue spending as profit levels are high, balance sheets healthy and interest rates accommodating.
The recent earnings’ season yielded a number of positive surprises. Many analysts were braced for disappointments but it was quite the reverse. On the whole, companies met or exceeded expectations. Some set records for sales and profitability. Management teams were also upbeat on their outlook.
So it is not all doom and gloom for the US. Exports are improving and could be more influential, especially if domestic consumption falters. Dollar weakness should continue to help the export outlook and reduce the huge trade deficit. Manufacturing has improved and, outside the residential sector, consumer spending could be sustained for longer.
Jenny Jones manages the Schroder US small & mid-cap fund.