Standard Life Investments

Published Article

Investment Week – US Equities Outlook


Today it is taken for granted that technology speeds the flow of information, empowers the transfer of knowledge and drives productivity. Yet somewhat surprisingly, a person's self-assessment of their financial health and outlook for better times remains stubbornly outdated. No new IT gadget exists to drive rapid changes in future expectations of prosperity barring a lucky lottery ticket. While the S&P in 2013 was up approx. 30% (usually a forward looking barometer of better times ahead) we now see investors nervously seeking positive data to hang their hat on at the end of the first quarter with the market up only about 1%.

Last year we tipped our hat to the Fed for providing 'cheap funding' which provided a significant number of firms the ability to refinance high cost debt and for some to modestly increase their leverage. The resulting cash flow was strategic to many as a tool to drive earnings growth with share repurchases rather than traditional demand drivers of rising sales and pricing power. At a more granular level, the S&P 500 Consumer Discretionary Subsector was the number one performing group last year, up about 41%, but the worst group YTD, down around 3%. Is this the beginning of a bear stretch or simply a short period of consolidation ahead of a bull market which has paused to catch its breath?

If you are bearish, there are two key issues that tarnish a bright scenario, namely employment and credit availability. Many authors of US Labour Force Participation Rate studies put forth cogent arguments for the decline from 66% in 2008 to 63% today (bureau of labour statistics). Optimists cite a natural decline from retiring baby-boomers while the cynics point to a large number of able but discouraged workers. Regardless of the precise mix of both factors, the trend remains negative and suggests job growth will be sluggish at best. As for credit availability, the combination of scars from the financial crisis and the new penalties imposed on financial institutions for inadequate underwriting has permanently skewed the risk/reward of lending. As a result, only the well-heeled are able to find credit which is hindering a range of demand drivers from startups to credit card applicants. The consumer still drives about 70% of GPD and without employment growth and lines of credit; growth will remain an artifact of a previous era gone by.

For the bulls, the strength of housing, lower fiscal headwinds, and the removal of emergency unemployment benefits will drive job growth. The premise of the last point being that the removal of an incentive to not work will drive a meaningful increase in nonfarm payrolls. The Bottom line is that the wealth effect of rising home equity values and a significant uplift in payrolls will do wonders for consumer sentiment and their penchant for spending. The University of Michigan survey of Consumer Confidence continues to slowly climb and with that so too will US GDP and the market.

Which camp is correct is always the conundrum of investing but my vote rests with the dogged and intractable optimism of the consumer, however slow they are to recognise their improved standing.

Ken Murphy, Senior Vice President - US Equities, Standard Life Investments