Wall Street: Better than you think

I expected Wall Street to rebound, but this is much more ... it's one of the best recoveries on record.

Summary: Recent data out of the US has been better than expected, with economic growth still managing to accelerate from what was already a blistering pace. Rather than a bounce back from a weather-induced slump in March, this acceleration is a return to trend – and indicators suggest the second half may be even better.
Key take-out: If the data holds – which it is increasingly looking like it will – the implications are extremely positive for equity investors. US stocks are likely to outperform Australian shares, notwithstanding our domestic economy’s propensity to persistently deliver upside surprises.
Key beneficiaries: General investors. Category: International shares.

I was wrong on the US economy. As it turns out, even my optimistic view was far too pessimistic and the US economy looks to be performing extremely well. I realise that Friday’s payrolls were a little lower than expectations at 142,000 in August from 212,000 the month prior – this was in fact in line with my view that US economic data would slow down a tad.

But while the temptation might be to try and feed off slowing payrolls in August in drawing conclusions, the truth is that it looks like the US economy is accelerating further still, rather than moderating from what was already a blistering pace of growth (as I had previously thought).

As Kerr Neilson from Platinum Asset Management points out in this edition, investors need to look overseas for growth as the trend of impressive returns in Australia matures (see Investing around the world).

This acceleration is more than just a bounce back from a weather-induced slump in the March quarter. We saw that rebound in the second quarter and it was strong at 4.1%. Indeed calling it a rebound is probably a little misleading as it’s looking like it might be more a return to trend. Growth in the last two quarters of 2013 was exceptionally high (averaging 4% compared to an historical average of 2.4%) and recent indicators suggest the second half of 2014 may be even better than that.

Chart 1: US ISM Index at thirty year highs!


Graph for Wall Street: Better than you think

Chart 1 shows the ISM index which is one of the best indicator series on the US economy. Numbers above 43 typically indicate an expansion in the US economy over time. At 59, the index is at its highest point since March 2011 and, as the chart shows, is at one of its highest points in about three decades. That’s a very good signal for growth.

Naturally, I would never suggest investors look at just one indicator. As good as the ISM is, it isn’t faultless. This is where durable goods orders come in. As you can see from chart 2, these are surging.

Now this is an important signal. It makes sense that if consumers and business are feeling more optimistic about the longevity of the expansion, then they’ll be more inclined to buy more expensive, hard-wearing durable goods. The data shows that this is exactly what is happening and it supports the signal from the ISM index above.

Chart 2: Durable goods orders surging


Graph for Wall Street: Better than you think

Increasingly it looks like the US expansion is entering an even stronger growth phase from what was already a very strong expansion. I know that policy makers will tell you it was one of the weakest growth phases – the post crisis recovery. But this isn’t true … not even close. The data actually shows it as one of the strongest post crisis recoveries on record – and it’s getting stronger.

Car sales are surging, up 6.7% in August and a near a decade high. Retail spending more generally is solid, rising nearly 4% over the last year.  Construction spending too is on a strong growth trajectory, rising nearly 7% in the three months to July and of course as we already know, the labour market is booming. More than 2.5 million jobs have been created over the last year and the unemployment rate has plummeted by more than 1 percentage point to 6.1%.

This is clearly incredibly strong, broad-based momentum. If that data holds, and I have to confess that I was sceptical that it could (it’s looking like I was wrong on that), the implications for equity investors are incredibly positive.

I’m already expecting a fairly strong rally coming into the end of the year. At the very least that’s what most of the market drivers point to in the sense that no one is short the market, weight of money will start to hit the market, while on the flipside, the ECB has decided to print money. This recent data flow backs that call.

It also highlights why I expect global equities – especially US stocks – to outperform Australian equities, notwithstanding a domestic macro economy that persistently delivers upside surprises to policy makers and markets alike.