26th November 2010
Certainly concerns about the strength and durability of the US economy remain palpable. As the Wall Street Journal reports here, economic forecasters expect the U.S. economy to remain sluggish next year, weighed down by high public debt, unemployment and business regulation.
But Jonathan Armitage, head of US equities at Schroders, believes there are ‘plenty of reasons to remain optimistic" on the outlook for corporate America in 2011. Certainly US corporates are doing rather well as the moment, as this Washington Post article highlights, with profits hitting record rates.
As well as the action US companies have taken themselves – such as cutting costs and restructuring aggressively early in the downturn – Armitage points out that the larger ones in particular will benefit from being truly global in their reach. That means, going forwards, they will be able to take advantage of strong growth rates in other parts of the world including Brazil, India and China. Indeed for some US firms, emerging market revenues account for a third to a half of all revenues.
This helpful Bloomberg article covers prospects for the emerging markets with a focus on the key players.
Then there is the quality of US companies that should attract investors: "US companies are often the recognised leaders and innovators in their respective fields. It is difficult, for instance, to envisage businesses such as Google or Apple emanating from anywhere other than the US.
Armitage adds: "The US has always been at the forefront of developments in sectors such as technology, healthcare and aerospace & defence – that will not change in 2011, or indeed at any point in the foreseeable future."
Another reason for Armitage being positive on the US is the recent revival in M&A. It has been supported by strong levels of free cash flow in the US and the generally healthy nature of corporate balance sheets: "Companies can either use their free cash to make acquisitions that support earnings or they can leave it on deposit where it will earn around a quarter of one percent – that is not a particularly difficult decision."
Evidence of increased M&A activity in the US is growing, with International Business here highlighting the technology sector is one that is set to experience feverish activity.
But while Armitage is positive on the outlook for large-cap US corporate, particularly those with a global focus, he cautions that short term market sentiment continues to be dominated by the outlook for the US consumer. "There are still concerns over the consumer and whether or not the recession has fundamentally altered their propensity to spend.
"While we have to recognise the consumer as a risk, it is worth remembering that it is the wealthier sections of US society that drive consumption. Importantly, these wealthy consumers have been less affected by the downturn and continue to spend."
Two issues will be critical over 2011 in determining consumer sentiment: housing and labour markets. On housing, Armitage reckons the market will not get "markedly worse" in 2011. Broadly, he is looking for the US housing market to have a neutral to slightly positive impact on growth in 2011. That might sound unimpressive but it will still be a significant advance on the drag on economic activity it provided during 2010.
As for labour markets, Armitage, as with housing, does not expect conditions will get too much worse than they already are. It is encouraging that temporary employment has already started to pick up, he says.
Armitage also points to the wide range of investment opportunities available in the US as another positive. He is particularly keen on areas such as energy and industrials. Diversified financials, meanwhile, is "an interesting sector" at the moment, he says, citing attractive valuations with the market assuming that profits will not recover to anything near the levels seen in the last decade.
"It is these types of anomalies that we seek to exploit; whenever the market is overly pessimistic in its assumptions there is always the potential for a positive surprise in terms of earnings, cash flows and margins. This is the ‘growth gap' that we seek to exploit."
But while he is generally upbeat on US equities, especially large caps, Armitage is concerned that the US Federal Reserve will make a policy mistake and inflation picks up faster than expected. Certainly having announced a further $600 billion of quantitative easing (QE), the Fed is unlikely to tighten policy any time soon.
"It is important that its eventual exit strategy from QE balances the risks to growth on one side with the obvious inflation risk on the other, particularly as productivity gains could be eroded if input costs are allowed to rise," he says.
As this Investment Week article indicates bond managers, for instance, are becoming increasingly concerned about the outlook for inflation in the US.