JAMES KINGHORN, senior investment manager at The Scottish Investment Trust on the U.S.
There is increasing speculation that another round of quantitative easing is on its way.
Strong corporate earnings have helped mitigate some of the bad news. However, corporate guidance on the outlook for the economy has been underwhelming and investors should be concerned expectations for the rest of the year, and for 2011 in particular, are still very aggressive.
Current consensus forecasts are looking for 15% profit growth in 2011, on top of the 30%-40% rise in 2010, to record levels. Given that operating margins are back to cyclical peaks, it seems unrealistic companies can generate record earnings while the economy is still in such a precarious position. Estimates appear likely to come down during the second half of this year and will weigh further on investor sentiment.
Concerns over consumer spending remain as same-store sales among leading retailers have been disappointing and it is difficult to see a strong rebound in spending in what is a key driver of the US economy, accounting for 70% of GDP. Unemployment remains very high and companies are unwilling to hire while the outlook is so uncertain and with capacity utilisation at relatively low levels.
Moreover, while the government and Fed have been doing a great deal in terms of providing fiscal and monetary stimulus, it is unclear whether this has had the desired effect. New legislation, including the healthcare reform bill and the financial regulatory act, as well as the expiration of the Bush tax cuts at the end of the year will create more costs for many individuals and corporates.
The Fed has said it will do all it can to keep the economy from another recession including quantitative easing. It will almost certainly need to as businesses and consumers undergo a long period of balance sheet repair.
On a more positive note, the large US companies have healthy balance sheets with non-financial companies in the S&P 500 sitting on a record $1,000bn in cash and equivalents. Cash and equivalents as a percentage of debt have risen to 40%, up from 27.1% two years ago. Also valuations are not challenging and investor sentiment is decidedly negative, usually a good contrarian indicator.
There is likely to be more negative macroeconomic data but it is not, for the moment, weak enough to suggest another recession. Once next year’s earnings expectations are re-set to a more realistic level later in 2010, which will probably drive the market lower from current levels, it would set the scene for a solid rally in 2011 as evidence the double dip has been avoided becomes clearer.
James Kinghorn is senior investment manager, US equities at The Scottish Investment Trust
