US economic fundamentals remain good, with corporate spending being the main driver of growth, but t...
US economic fundamentals remain good, with corporate spending being the main driver of growth, but there are concerns about higher commodity prices and whether or not Asian banks will keep buying the dollar.
Strategist Tom Elliott at JP Morgan Fleming thinks the US is running above trend growth. Company earnings have remained good following ongoing cost-cutting measures but corporations have been spending more money on capital expenditure.
Frederic de Merode, senior strategist at Fidelity, points out that of the 477 companies in the S&P 500, 373 reported higher earnings, 86 reported lower and 17 were unchanged last year. Although the number reporting a lower earning was higher than the previous year, de Merode feels these are generally indications of strong trends.
"The sectors that have seen the biggest boost in earnings growth has been in energy, materials and utilities. The demand for energy has been high from Asia. The sectors have all grown on the back of higher commodity prices," says de Merode.
However, de Merode warns that financials have had a tough time over the past year as the Fed has been raising interest rates. The regional banks make money through lending and the servicing of debt is more expensive.
Although higher commodity prices have been good for the energy, materials and utilities sectors, there are concerns this could lead to an increase in inflation. Elliot warns if the Beige Book, which looks at the US current economic conditions, shows signs inflation is rising there is a danger of an acceleration of interest rates.
de Merode thinks, however, there has been little evidence that consumers have been hit by inflation as a result of higher commodity prices. The Consumer Price Index (CPI) has not had any major pick-up in inflation as a result of globalisation of competition. The pick-up in inflation has only been seen in the Producer Price Index (PPI) with margins being squeezed in the industrial and IT hardware sectors. This is because the manufacturing industry has been the biggest buyer of steel and copper and in need of oil.
de Merode says: "There has been a debate on how far interest rates could go up. It is most probable that interest rates will go up this year but it will be difficult to gauge the plateau. However, there is a general feeling unless there is a shock, the economy seems to be going along fine.
"The political risks seem to be disappearing for the US, and with the elections in Iraq the future looks to be less volatile. Geopolitical issues have been fading and there is less concern that volatility of political uncertainty will impact the economy."
Haydn Davies, chief economist at Barclays Global Investors, also thinks underlying inflation remains lower than its average rate over the past decade and does not look likely to get out of control.
The main cause for concern for the US, Davies feels, is the dollar and talks of Asian banks diversifying into other currencies.
Davies says: "The dollar has been under pressure ever since the collapse of the technology bubble. The dollar has come under renewed pressure lately due to speculation that central banks around the world, and particularly in Asia, are intent on selling some of their dollar holdings. Asian central banks are likely to broaden their currency investments as their economies become less dependent on US demand, this is likely to take place over many years."
The Bank of Korea has indicated that it might diversify $200bn into other currencies. However, Elliot does not think it is likely they will sell their present positions.
Although the Bank of Korea has given some indication it may diversify in currencies it is going to buy, de Merode thinks it is more important to the US to know what the Bank of Japan is thinking of doing. The Bank of Japan is the biggest holder of dollars and the bank has indicated it is not going to sell. The US is important to Japan as it is a major buyer of its goods, Japan needs a weak yen so other countries will buy its exports. It is important for the Bank of Japan to buy dollars to keep a weaker yen.
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