US Economic Outlook is Positive, says Canada Life

Popular opinion suggests the US economy is nearing the end of the cycle - and the next stage is a recession. But the Fed is bullish

David Brenchley 14 August, 2018 | 7:23AM
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US dollar, US economy, Donald Trump, tax reforms

The US economy has plenty left in the tank, according to David Arnaud at Canada Life Investments, despite numerous key indicators telling investors that it is very late in the economic cycle and we should prepare for a recession.

For US bears, there are clear signs we’re approaching the end of the bull market. The sheer length of the current expansion, already the second-longest in US history at over nine years, rings alarm bells.

For others, the fact that the labour market is so tight – with the unemployment rate running at an 18-year low 3.9% – usually suggests the economy is running at full speed. Elsewhere, previously rising margins for S&P 500 companies have started to stabilise, suggesting US firms are losing their firepower.

Bill McQuaker, portfolio manager on Fidelity’s Multi Asset Open funds, says some data points show signs of a slowdown in US growth. The Institute of Supply Management’s latest non-manufacturing index, for instance, declined more than expected in July.

While a reading of 55.7 still puts the services sector firmly in growth territory, McQuaker says it’s beginning to indicate that the US is slowing. Interest rate sensitive sectors like the housing and car markets, he adds, have been slowing for some time. “The next data point or two for either of those, but particularly housing, could be quite significant.”

Siding With Bullish Fed

Arnaud, who runs the Canlife Global Bond fund, admits these are all clear risks. However, he’s inclined to side with a more bullish Federal Reserve.

The central bank points to positive conversations with companies that confirm they are in rude health, with a healthy jobs market and growing order books offsetting a slight rise in input cost pressures.

And Arnaud notes “there’s a whole lot of other indicators that doesn’t give you the same warning signs”. “They actually tell you there’s still a few years to go of this good economic cycle.”

These indicators include inflation, which at the Fed’s 2% target remains “mild”; consumer and business confidence, which have been declining but still read as positive; company leverage, with no signs of a binge borrowing spree yet; and default rates not picking up.

Garrett Fish, portfolio manager on the Morningstar Bronze rated JPMorgan American investment trust (JAM) is similarly bullish on the US economy and makes the same points as Arnaud.

He’s conscious, though, that “something’s going to happen that will upset the apple cart – I just don’t know what; there’s no smoking gun right now. We just keep chugging along.”

It’s been suggested by some, including McQuaker, that the sugar rush of Donald Trump’s tax cuts have driven much of this year’s growth. Being a one-off boon, their impact will soon fade and inevitably lead to a slowdown.

Arnaud disagrees, noting that any extra cash in the pockets of workers will have been eroded by higher gasoline prices. Therefore, any bonuses will generally be used on keeping vehicles running, rather than being frittered away.

Trade War Impact

As a result, Arnaud says he doesn’t think a recession is imminent. “Only a big external shock can derail this view,” he explains.

An escalation of trade talks between the US and China could be just that big shock to the system. But even on this subject he’s much calmer than some: “I’m not dismissive of the trade war, but at the moment I’m not worried.”

Numbers-wise, he weighs up the $1.5 trillion worth of tax cuts the US consumer and US companies have been given against the tens of billions of dollars that trade tariffs would impact. “The impact of the fiscal stimulus is way more important than the potential costs we might see of the trade war.”

One concern he does have is the effect the trade rhetoric has had – and will continue to have – on confidence. Fed governor Jerome Powell has already cautioned that company bosses he’s spoken with have admitted to holding back investment decisions due to the trade ructions, much like UK CEOs are over Brexit uncertainty.

Something else that could pose a problem down the line are those rising interest rates, according to Fish. While he says tax reforms have been “unequivocally good”, they have meant firms and the Government are now more highly levered than before – if not significantly so.

“That will be a problem if interest rates go up then it has to choke it off. It’s just, when does the market and the global investor base start to worry about that? I don’t know,” he adds.

But Arnaud is not deterred by those rising rates, preferring to take them as a reason to be bullish on the US dollar. He says he’s long the greenback, which will see a supporting influence in the shape of rising rates.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
JPMorgan American Ord961.00 GBX0.84Rating
LF Canlife Global Macro Bond C GBP Acc125.19 GBP0.10Rating

About Author

David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk

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