US well on the road to recovery

Since the October 2011 lows, the S&P 500 is up very strongly, and both the unemployment and housing picture appears to be improving in the US. Even though market volatility has recently increased, I still believe that the upward trajectory for the US economy is sustainable, albeit with the anticipation of bumps along the way.

Nothing goes up in a straight line and it would be shortsighted to predict that a smooth upward trend would continue indefinitely. Despite the abundance of positive signs driving current sentiment, oil price fluctuation, the prospects for China, and the decelerating of US earnings growth and profit margins must all be taken into consideration when discussing the sustainability of the US recovery.

In recent times, there have been concerns that oil prices in the US are high enough to break the economic recovery but it is important to remember that is the rate of change, rather than the scale of the price, that is more significant here. However, as oil prices have recently steadied, it is apparent that both consumers and businesses have demonstrated the ability to adapt to price volatility. There are also notable offsets to the current energy price increases that were not in place during the price spikes inflicted on the market last year, nor back in 2008 when we experienced a trend of increasing oil prices.

With the job market continuing to move in the right direction albeit at a slower rate more recently, a growing consumer confidence, a pick-up in credit growth, in addition to aggressive stimulus measures from the Fed – US consumers are now better positioned to weather volatility in energy prices. Crucially, it is important to consider that energy price inflation experienced last year was largely spurred by the second round of quantitative easing by the Fed, whereas the recent driver for fluctuation in the price is global growth. In addition, overall spending on energy as a percentage of disposable personal income is currently less than 6 per cent in the US, this is down from the 8 per cent of the early 1980s.

Those analyzing the sustainability of the US recovery are also keeping a close eye on developments in the Far East. Fears of a hard landing for China’s economy, resulting in a drag on US and global growth, are widespread but arguably premature. Advancement in China has certainly slowed, but nevertheless a strong posting of 8.1 per cent growth in the first quarter of 2012 should abate cause for immediate concern. China’s government moved to engineer a slowdown last year and, with the exception of the property market, China has now shifted to easing. Inevitably monetary policy operates with a lag, and economic growth is likely to continue to slow during the first half of 2012 before turning higher again.

We will be receiving more information at the corporate level over the next several weeks as first quarter earnings season heats up. There appears to be more uncertainty in this season than we have seen recently, but we have seen analyst forecasts revised higher recently. This reporting season could provide the next near-term catalyst for the markets as some positive surprises and commentary could provide further fuel, while disappointment could move stocks lower.