InvestmentsAug 11 2014

So far, so good for a grassroots recovery

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Among investors, the US economy has been perceived as leading the global economic recovery for some time. Based on recent data, that story seems unlikely to change.

According to the first estimate, the US economy grew at 4 per cent in the second quarter of 2014, allaying any fears markets had about the contraction in the first quarter. Many had confidently predicted the disappointing first quarter result was a one-off due to severe winter weather. Nevertheless, the pace of the growth in the following quarter took many by surprise.

Keith Wade, chief economist at Schroders, points to consumer expenditure as the largest contributor to quarterly GDP growth. He also notes that consumption of goods, in particular motor vehicles, was stronger than it had been in recent quarters.

“Government spending made a negligible impact, but the positive contribution from changes in inventories was very large (+1.7 percentage points),” he says. “Normally, the large contribution from inventories would be a concern, as it would signal demand not keeping up with supply. However, the rise in the second quarter follows contractions in the previous two quarters and so is to be expected.”

Underlying strength

Wouter Sturkenboom, investment strategist at Russell Investments, cautions that the 4 per cent figure is a little exaggerated by the impact of inventories.

“What we need to realise is that US GDP growth in general is progressing at a fairly stable, steady rate. This shows that the underlying recovery remains on track, no matter what the volatility in the first and the second quarter has told us,” he adds.

Where the economy is struggling to get beyond overall GDP growth of 3 per cent, Mr Sturkenboom concedes that the underlying strength of the US economy is being inhibited. “There’s this secular force that is keeping the recovery back. A very clear sign that that’s still in place is the employment situation,” he says. “On the one hand, we’re seeing improvements – we’re seeing jobs being generated – but we’re seeing very little real wage growth.”

With the reporting season well underway in the US, investors are keen to see whether the recovery has fed through into corporate earnings.

Kully Samra, managing director at Charles Schwab UK, says: “I think earnings are looking OK. Some people would say they’re mixed but I think they’re OK.

“I think what has happened, though, is the companies that have missed [expectations] have been punished more severely. That shows that we’re expecting a slightly higher bar in terms of earnings.”

He thinks those companies that are reporting earnings will redirect money towards capital expenditure, which has been lower than expected. “We’re going to start to see this investment in capital expenditure pick up, which will have an economic snowball effect. That will continue to improve earnings, and to improve wages and consumer expenditure. We’re probably some way to starting to see that happen.”

Data coming out of the US continues to do so against a backdrop of tapering. The Federal Reserve has confirmed that quantitative easing will come to an end in October this year, but where chairman Janet Yellen stands on interest rate rises is less clear.

Richard Lewis, head of global equities at Fidelity Worldwide Investment, believes that if US GDP were to be in the 3-3.5 per cent range at the end of the year, this could make a tightening of interest rates more likely.

He says: “Much will depend on the Federal Reserve chairman Janet Yellen’s ability to guide the market and get the timing right. After four-and-a-half years of near-zero interest rates, any kind of monetary policy tightening is going to have some unintended consequences.”

Tapering plan

There is a growing sense that Ms Yellen and her colleagues have been caught on the back foot by the pace of the recovery.

Mr Samra recalls her first press conference, where she was prescriptive about their expectations. “Clearly what they’re saying is they’re going to be data-dependent. They have given us a very clear path as to what they’re going to do with tapering but they’re trying to be a little less clear on interest rates because clearly they don’t want to be tied to anything.”

Ellie Duncan is deputy features editor at Investment Adviser