A question of growth
Posted on 20 June 2014
...business investment rose in the first quarter, a sign that the recovery is becoming more balanced and sustainable
Recent economic data in the US appeared to move in the opposite direction to what was expected. GDP declined 1% in the first quarter, although a stream of other economic data points portended a much different result. Indeed, the consensus expectation for first-quarter growth was in the order of 1.6%. A brutal winter, impacting home buying and business spending, was the culprit for the disappointment.
A look at the components of GDP reveals reasons for optimism. Healthy consumer spending (which was revised upward) along with the decline in inventories suggest a re-stocking is in the offing. This inventory build and the unleashing of pent-up demand will revitalise growth in the remainder of the year.
Although it was hardly the beginning of the year investors anticipated, prospects for the balance of 2014 remain good. The consumer appears to be in fine form, and business spending seems to be stirring, as evidenced by the spate of corporate acquisitions announced this year. Furthermore, corporate profitability in the US does not map to a stagnant economy. To wit, first-quarter profits of the S&P 500 Index grew 4.7% on revenue growth of 2.6% . Indeed, performance of the market itself foots with earnings growth advancing 4.3% this year.
Our expectations for the US market are unbowed by the rough start. We expect overall growth for the year to be in the order of 2.5% to 3%. A quarter in which growth is above 3.5% seems likely as buyers transact purchases postponed in the first quarter. As growth improves, more investor attention will shift to when the Federal Reserve will start to raise short-term interest rates and whether signs of upward price pressure in the economy are cause for unease. These are legitimate concerns for sure, but they are not imminent threats to prosperity.
Growth in the eurozone remains sluggish: first-quarter GDP advanced 0.2% (non annualised) with inflation within the bloc running at 0.7% – less than half the European Central Bank (ECB)’s target of 2%. The bloc’s struggle to sustain forward economic momentum is creating a chorus of concern over the threat of a deflationary spiral taking hold. These fears are prompting calls for a more muscular approach from Mr. Draghi and Co. to use the central bank’s balance sheet to assist in generating economic growth.
June may see the ECB’s move to negative deposit rates and/ or some form of targeted liquidity measures as a nudge to banks in the periphery to beef up lending to small and medium sized businesses. In spite of this muted economic backdrop and little to cheer on the corporate earnings front, European equities have continued to forge ahead, perhaps aided by reasonably benign outcomes from both the Ukrainian presidential and European parliamentary elections.
We still see core Europe as the region with the most upside for corporate earnings, and economic growth is expected to be positive this year and next. Within developed markets equities, we would still urge investors to put their money in Europe and the US.
The consumer-led rebound in the UK leaves GDP close to pre-crisis peaks. In addition to ongoing retail strength, business investment rose in the first quarter, a sign that the recovery is becoming more balanced and sustainable. Of the major western economies, the UK is probably most ready for monetary normalisation, and the US is a close second. With this in mind, we suggest investors tread carefully and lightly in the bond market, and look to the equity markets in developed economies for exposure to the pickup in growth.
Read the full June Compass [PDF, 1.2MB].
Hans Olsen, CFA Chief Investment Officer, Americas