SIMON LAING, portfolio manager of Newton American fund on North America
It is hard to be upbeat about the outlook for the US economy.
GDP growth in 2011 looks likely to be around 2%, well below what would be expected after the depth of recession the US went through in 2009, and certainly below what the Fed would like to see. The main drag on the economy continues to be the effect of consumer and government de-leveraging and this is a multi-year phenomenon.
Unemployment remains high and until business confidence returns, there is unlikely to be much improvement. To date, the level of corporate investment has been very disappointing.
The anti-business policies emanating from Washington are dampening confidence across corporate America. This should improve after the mid-term elections in November.
Looming over the equity market is also the threat of sovereign defaults. Dubai and Greece have been warning shots that remind us of the treacherous state of government finances. The US deficit is a problem that will have to be addressed and the current administration has done little to tackle it yet. This is an issue investors will keep coming back to over the next several years and will contribute to increased volatility.
Given this backdrop, it is easy to see why bearish investment commentary is deafening and the equity market is struggling. However, we are much more upbeat when we analyse individual company prospects. Furthermore, given their valuations, there appears to be plenty of opportunities.
There are areas of secular growth, such as smartphones, where the power of adoption will trump macroeconomic woes and provide strong growth for well-positioned companies. Valuations are also low in industries that have been in a downturn for several years, such as housing. Many homebuilders trade at large discounts to book value where the book has been written down significantly over the last six years. Fundamentals are poor but will improve eventually and at such valuation, the downside would appear small compared to the upside.
More generally, large caps look compelling value. Including dividends, since January 2000, the S&P 100 large-cap index is down 22% while the S&P 600 small-cap index is up 95%. The large-cap index has outperformed the small-cap index in only two of the last 10 years, and even then it was by a paltry 2% and 5%. In 2000, the median P/E of the largest 25 US stocks was 50x. Today it is 12x. Large caps certainly merit more investor attention.
Simon Laing is portfolio manager of Newton American fund
