U.S. Recovery was never what it seemed

The market rout that has characterised the first weeks of 2016 is a function of investors waking up to the level of indebtedness in China and questioning how it could impact global, and in particular US, profits growth going forward, says Newton’s (BNY Mellon) Iain Stewart.

“In some countries indices have given up their entire 2015 gains and in other cases even more,” says Iain Stewart, investment leader of the Newton Real Return team. He adds that now the focus has turned to whether the US can continue to diverge from the rest of the world in terms of monetary policy and economic activity.

“We have believed for some time that the US recovery is not as robust as its policymakers would like us to think it is. From where we sit, a manufacturing and industrial recession is already in place and profits and cash flows in companies are already down.”

Stewart says US bulls point to the increase in employment within the world’s largest economy in support of a strong and growing economy. He views it slightly differently. “The times when job opportunities and employment levels have risen over several years and are high tend to be a leading indicator of the end of the economic cycle. So the idea this is indicative of the start of an expansionary period is a bit odd.”

At Newton the view is the US Federal Reserve left it too late to raise rates and the feeling is now the Fed is equally likely to commence another round of stimulus as it is to raise rates further.

“The problem is the Fed has created and sent signals to the economy to invest while simultaneously giving low hurdle rates to access that money. The result is all sorts of capacity in areas where it is not necessarily needed. At the same time we have new applications of technology transforming the services sector and making it easier to provide even greater output,” Stewart explains.
As to when and if there will be buying opportunities arising from the current correction, Stewart believes risk assets will need to fall further. He says the Real Return team has picked up a few names on the equity side and traded out of some names that have performed extremely well. However, he is yet to see the major shift needed to put in place a structural change from defensive companies towards more cyclical names.

“So far it has been largely driven by the commodity/energy complex and by emerging markets. On a headline basis you could make the case that emerging markets now look cheap but the kind of businesses we want to own are still valued in line with global stocks.”

Meanwhile, he says the ‘cheap’ businesses are limited mainly to those related to the commodity/energy complex so far, along with some state owned enterprises. Similarly, in credit markets neither higher quality nor higher yielding names are in ‘bargain bucket’ territory. Given the widespread increase in corporate indebtedness he believes there is still further scope for contagion from the poorer quality end of the market to higher quality names.