No wonder UK investors are so glum about Wall Street's prospects: rising US interest rates, a weak d...
No wonder UK investors are so glum about Wall Street's prospects: rising US interest rates, a weak dollar against sterling in 2004, the level of the trade deficit and concerns about slowing GDP and corporate earnings growth all combine to take their toll on sentiment.
However, it would be fair to say that the level of pessimism about US equities seems unjustified in the context of the positive messages coming from US companies - and given the general health of the economy.
Economic growth is, in fact, stronger in the US than the UK. So far in 2005, the dollar has risen, jobs are on the increase and house prices are less of a debt burden for US consumers, who have continued to spend compared with their counterparts in the UK. The only area, in fact, where the UK fares better is in holding a more healthy trade deficit.
A relevant question is how much further monetary policy will be tightened. The Fed funds rate has risen by 25 basis points (0.25%) nine times in the last 12 months, to its current level of 3.25%. The market is telling us there is almost an 80% chance that rates will be raised by 25 basis points at the next meeting on 9 August. Beyond that, there is a growing consensus that 3.5% could be the peak in rates. A Fed governor recently said he believed we were in the "late innings" of this tightening cycle.
While economic data has pointed to slower growth, oil prices could magnify the impact of the Fed's tightening. Interest rates could reach their peak at a lower level than investors currently expect, which could prove positive for bonds too. This could all change if there were to be a sudden pick-up in economic growth and/or a rise in inflation. But future growth looks gradual, not sudden.
Moreover, it is quite possible that inflation may start to decline. Despite oil price increases, inflation is not generally seen as a problem. The year-on-year increase in US house prices is running at 8.82% this quarter compared with 12.5% in the first quarter of 2004. In addition, the consumer remains all-powerful, making it difficult for companies to pass on price increases. Perhaps most significant of all, the increasing presence of China as a leader in manufacturing has kept producer prices down worldwide. So, all in all, we do not believe inflation is a problem.
If US rates really are in their "late innings", then the next game in the series is looking good. In the last 20 years, the US stock market, on average, has gained 17.5% in the following 12 months after the last increase in rates. If the situation today bears any resemblance to the past, then this raises the probability of further positive returns in the 12 months after the last increase in rates. Surely one reason for investors to be more optimistic about Wall Street's prospects.
US is underappreciated and over-feared by international investors.
Plausible that high oil prices could be positive
When Fed rates stop rising, the US economy traditionally booms.
Smoking biggest culprit; obesity second
Average earner will gain £840 in 2018
Will also move heritage items
Responding to letter from Treasury Committee chair Nicky Morgan