As the consumer boom peters out hopes are focused on the manufacturing sector to take over as the main growth driver.
In spite of the recent hike, interest rates are still at historic lows. “The Fed has plenty of room to raise them to 2%,” says John Storkerson, portfolio manager, global core equity, at Putnam Investments. “ The yield curves that we’re using are already reflecting a rate of 2% by the end of the year. With growth of 3 to 4%, a rate of 1.5% is silly.”
Oliver Adler is head of global investment strategy at UBS Wealth Management in Zürich. “The Fed will be cautious about raising interest rates because household debt levels are high and any sharp increase in rates would put a lot of stress on debtors.”
There is a view that the main driver of growth is moving from the consumer to the manufacturing sector. “We have had view that things related to the investment cycle should be doing better so producers of capital goods should benefit,” says Adler.
Haydn Davies, chief economist at Barclays Global Investors, also sees the consumer as a major issue. In his August Market Outlook he notes “it is household spending that has caused the most concern. Spending on big-ticket consumer durables, such as cars and household appliances, has hardly grown since last autumn despite improving consumer confidence.”
He adds: “There are several reasons. First, the summer has brought an end to the tax cuts that boosted household incomes by around US$60bn (e48.6bn)last year. Second, as bond yields have climbed, so too have mortgage rates, with the result that households can no longer lock in a lower cost of borrowing and boost their purchasing power. Finally, higher oil prices – and in particular petrol prices – have meant that real wages are falling for the first time since 1995. Moreover, the boost to household incomes from a pick up in hiring has waned.”
But he provides some comfort: “The weaker US dollar, in particular, is a key factor in the US market’s favour that helps to explain why investment analysts are still more upbeat than their counterparts elsewhere.”
Putnam’s Storkerson takes a similar view. “Propensity to save is rising at the margin; people are little bit cautious.”
He adds: “A relatively weak dollar should be positive for manufacturers and the export scene. And I think we’re starting to see better capital spending outlooks for a lot of companies. Inventories are very low and we have seen very little in terms of updating of processes. We have seen a lot of production going overseas and companies are reacting. That component of growth is likely to be around for a while.”
Overall the outlook for equities looks quite positive. “You will see a good environment for equities because many of them have been caned,” says Putnam’s Storkerson. “At the beginning of the year they were not overvalued; since then, another 20% year-on-year growth in earnings and a fall in the price of equities by 4% to 5% down suggests to me that they’re not overpriced now and look cheaper than bonds.”
Adler of UBS believes that the market is now undervalued by up to 5%. “We should have confirmation in the next couple of months that economic expansion and profit growth are continuing, although not at a fantastic rate. So I would not be surprised if by year-end the market was 5% up on the year.”
In terms of sectors, Adler notes “the worry about the consumer led recovery petering out has benefited the defensive sectors like consumer staples, utilities and pharmaceuticals.” Meanwhile energy has acquired a special status on account of the increasing price of oil.
Storkerson believes that there will be a shift in popularity from small to large cap. “It has already started,” he says. “Small cap portfolios have definitely underperformed their larger cap cousins, and the valuations of many large cap companies in the US, having been left behind, now look rather attractive.”
The overall picture is clouded somewhat by the uncertainty over the price of oil. It seems that the market is preoccupied with geopolitical issues, and with no swift resolution in prospect, the defensive equities may remain popular for a while longer.