The growth challenge for America

We have just seen former US Treasury Secretary Larry Summers lament the lack of strong economic acceleration in the current recovery.

It seems he, and others, suggest that “economists” are at a loss to explain why the US economy has not recovered in a more historically typical robust fashion. This so-called conundrum is, however, actually no surprise whatsoever. Once one recognises that the US, Europe and, to some degree, Canada and Australia, are in fact members of the “old first world”, it all starts to make sense.

My personal outline of the new global economic structure, that being the “old first world” as mentioned above, in comparison to the “new first world” of Asia and Latin America, is useful in helping to understand that things will never be as they were.

This is not a criticism of the European or US situation, but simply recognition that the US has done its part historically in leading the world in the development of democracy and capitalism. Having done so, and having continued to advance economically, as well as legislating new regulations over many generations, two things have occurred. Firstly, profit margins have been incessantly squeezed, and regulation has become a pursuit in its own right.

The outcome is that it is harder than ever to do business in the US, at the same time that profit margins are extraordinarily difficult to maintain.

This does not mean it is the end of the road by any stretch of the imagination. The US, as I have previously written, is now experiencing a renaissance in entrepreneurial spirit that is driving fresh innovation, which is breathtaking on a global level. Yet, it will remain a complex and difficult economy in which to do business for many American companies. America is more than in recovery mode; it is just that the same stellar levels of growth once attained should not necessarily be expected to easily return. This may well be about as good as it gets for the US economy in a general sense.

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I actually expect the US economy to grow at above 3% next year, and even close to that in this last quarter of 2013. Yet, we should probably not be expecting much more than low to mid 3% growth over the next few years. I hope I am wrong, and the US recovery surprises even this bull. But, in the interim, it is the rest of the world economy that will continue to help drive US corporate profits sky high.

Remember, more than half the revenue of the S&P 500 companies comes from overseas affiliates. This is why, even with more modest domestic economic growth during the recovery phase than has historically been the case, the stockmarket is still surprisingly cheap.

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Some people wonder what I am talking about when I suggest stocks are cheap here. Are we not at record highs? Yes, in absolute terms, but the world is an ever-larger place with ever-greater efficiency and profitable opportunities. It is only to be expected that we should be at all-time record highs, but what is even more exciting is that we are still at relatively modest price-earnings ratio levels.

In previous major bull markets, the top of the market was seen as PE ratios as high as 22, and even 31. So markets, given they are still to price in strong global growth, fund managers are still badly underweight, and corporate profits are likely to increase substantially, can only be viewed as seriously undervalued at current levels, regardless of the absolute historical highs we continue to see.

Overall, the US economy will continue to perform well, feeding corporate profits along with a very strong rest-of-world economy.

The dominant risk then for the equity market, in a big picture sense, remains upward acceleration! We saw the lows for the next 10 years some while back, and there is plenty of room still to fill toward my Dow Jones Index target of 20,000, and higher.

While US economists scratch their heads, the fundamental reality of which they seem unable to fathom will continue to drive stocks to far higher levels.

Clifford Bennett is chief economist at Investor Unity. www.IU.com.au/UP