Let us start with the reasons to be cheerful about the US economy. The brightest star must be the housing market, where there are clear signs of a recovery.
Housing starts accelerated throughout 2012 culminating in December when they were up 12.1% from the previous month and 36.9% from a year ago.
This is encouraging as it shows housing is now a tailwind rather than a drag on US GDP. There is also the related impact of improving both consumption and consumer sentiment. As mortgage lenders continue to repair their balance sheets they may become more inclined to provide mortgages, which would provide some surprise to the upside.
Another area of encouragement in the macro situation lies in employment levels. Unemployment peaked in 2009 at 10% and has been gradually falling ever since: the reported rate for December 2012 is 7.8%.
Even more significantly, the Fed has actively linked its monetary policy to employment levels, by pledging to keep interest rates at, or near, zero until unemployment falls below 6.5% or inflation rises above 2.5%. As more Americans go back to work, the recovery in the economy should gain momentum through increased consumption.
But it is not all good news, with ‘debt’ and ‘ceiling’ replacing ‘fiscal’ and ‘cliff’ as the two most disliked words in the market. Policymakers might have made headway with tax increases at the beginning of the year, but many questions remain about the spending cuts that still need to be agreed, and that have been delayed for two months.
Even at the time of writing, the House of Representatives has just passed a bill allowing the government to continue to borrow money until 19 May, further delaying this pressing issue. The longer-term ramifications are being overlooked, namely the continued expansion of the economy’s debt-to-GDP ratio which currently stands at 103%.
With profit margins at all-time highs, the forecast rise in margins in 2013 is looking unlikely. Business investment is playing a key role in the current high margins as lower levels of reinvestment rates have increased current profits. But this is not the best strategy for boosting long-term earnings growth.
We now struggle to foresee better-than-expected earnings and revenue growth for the S&P 500; if we look back to the last two cycles, a peak in net profit margins preceded a downturn.
Nathan Sweeney is an investment manager at Architas
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