Despite the war in Iraq drawing to a close, the prospects of an upturn in the US economy are no better than before hostilities began. Domestically, the US is facing the same problems as before the conflict, as well as some new difficulties.
One of the fundamental issues is the slide in earnings' growth. Before the war, growth was widely predicted to hit 10 per cent by 2004. But many fund managers doubt it will achieve half that level, with the latest figures suggesting a more realistic target of 4 per cent.
Foreign & Colonial Investment Trust fund manager Jeremy Tigue says: “We thought earnings' growth would be around 10 per cent but with each passing month that figure looks increasingly unlikely. Four per cent seems about right. We are thinking very cautiously about equities.”
Tigue says the most immediate problem facing the US is securing peace in Iraq. He believes this will be a long and costly exercise, with the US taxpayer picking up the bill. As a result, he has just 25 per cent of the portfolio in US stocks against an internal benchmark of 40 per cent.
Tigue's position is common. Most fund managers believe the US is overvalued. However, some see hope in the fact that Congress has sanctioned a huge increase in defence spending over the next 10 years, which they believe will boost the economy. But the flip side is that it will add to the near $300bn budget deficit.
Hargreaves Lansdown investment manager Ben Yearsley says: “Bush is trying to push through massive tax cuts which would help consumers but put even more pressure on the deficit. I just cannot see the economy getting any better. Some firms will do well but the indices will go nowhere.”
While the FTSE 100 fell by 35 per cent over the three years to April, the Dow Jones Industrial Average was down by just 19.9 per cent. This has led some observers to wonder if the Dow has another 1,000 or 2,000 points to fall. But with just 30 stocks – none of which is weighted by market capitalisation – the Dow is not seen as a particularly representative index. More accurate is the S&P 500, which has plunged by 37.74 per cent in three years.
JP Morgan Fleming Asset Management strategist Tom Elliott says: “The main drivers of gross domestic product are looking sickly. Only defence and transportation have delivered any real growth. We expect there to be more earnings' downgrades in the next few months but there is always the question of waiting to see what happens in the second half.”
Elliott believes the weak dollar could prove a fillip to exports but says JPMF's global portfolio remains underweight in the US, a reflection of its view that US stocks are overpriced. The company prefers the UK and even the Pacific region, which Elliott believes has superior balance sheets and fast earnings' growth.
However, some IFAs believe the US remains as much of an investment opportunity as countries with lower current valuations.
Simpsons of Brighton IFA partner Andrew Merricks says: “The valuation argument is a red herring. By saying the US is more expensive than the UK, everyone is basically saying both countries have decoupled. People just cannot get over the fact that what happens in the US happens here to a greater or lesser extent. Consensus is always wrong. Contrarians make money.”
Merricks believes there is a decent chance of a US recovery in the near to medium term but admits a weak dollar makes life difficult for sterling investors. Nevertheless, he says he would happily steer a client towards the US if they were taking a longer-term view.
Although US-based fund managers admit earnings' growth is worrying, they say investors should be heartened by the strides the Bush administration has made in terms of corporate governance. Allied Dunbar Life American fund manager Stephen Moore says: “The issue is whether people can look through negative earnings' revisions to see potential economic growth. There is a political will to keep a good environment for corporate America, such as Bush's tax cuts, and investors will see a greater degree of transparency.”
Moore dismisses the significance of the defence budget secured by Bush, pointing out that the cash injection never filters into meaningful areas of the economy. But he does not see the budget deficit as a problem. In his view, the trade deficit is far more threatening. Nevertheless, he says it is not enough of a reason to be negative about the US.
Bates Investment Services head of investments James Dalby says whatever investors and IFAs feel about the US, they cannot afford to ignore it. It is probably still the fastest growing economy worldwide. Interest rates are low and US monetary policy is usually fairly successful. You would be a fool to dismiss it,” he says.