Old Mutual’s Heslop: US cloud has a silver lining


It seems the jury is still out over the future direction of the US equity market. Not even a month ago the S&P 500 index flirted with all time-highs, prompting the bulls to wonder if investors really could be the beneficiaries of a seventh successive year of share price gains. Up until then the bears appeared to have had the upper hand – cue recent downward revisions to Q1 GDP numbers, softer than expected retail sales in April and the havoc wrought on company results from a stronger dollar.

I’d counter this pessimistic sentiment. While exporters were hit in the Q1 results season (and yes 45 per cent of S&P companies are overseas earners) domestic companies fared relatively well. Regarding softening GDP numbers, we bulls prefer not to talk about output but national aggregate income which, for the first quarter, registered 1.4 per cent annualised growth, according to Capital Economics data. Economists still think there’s no reason for the US not to register 2.5-3.0 per cent growth in the second quarter annualised.

For me it seems as though we are still in the sweet spot of equity investing. The risk of the US Federal Reserve tightening has been kicked a little bit further into the long grass and, if the IMF has its way, is likely to stay there for some time to come. Yet raising rates is a sign that the economy is not only off life-support but recovering well in the process.

So let’s focus on what we know so far. Knock-out non-farm payroll numbers for May aside, if ever there was a sign of confidence returning to the US economy it’s in the escalating value of M&A deals. In May alone these totalled a staggering $243bn, according to Dealogic, which if this rate continues could well top 2007’s record. If management didn’t believe the economy was stable they wouldn’t be committing such large amounts of cash to buying other businesses, surely?

And corporates are right to be optimistic. The US economy is one of just three to experience self-sustaining growth in 2014 – the other two being India and the UK. Corporate margins are nearing 50-year highs and, unlike many, I see no reason for them to revert to the mean given the double tailwinds of a fall in oil prices and advances in technology. So while optimistic on the economy, my only real concern is that the rate of corporate investment spend needs to increase. Companies are still in the ‘let’s return cash to shareholders’ mind-set, rather than ‘let’s invest in plant and machinery’ mentality.

Unsurprisingly, given the concerted actions of central bankers to drive down bond yields and whip up demand for equities, risk appetite has increased substantially from its October 2014 lows, with investors favouring growth stocks over value. Although, as most US equity investors will know from bitter experience the rotation from growth to value styles and back to growth could change anytime soon.

The recent correction in global bond markets suggests that point may not be too far away. While style volatility has been less pronounced in the US than Europe that’s not to say it doesn’t exist. Watch this space. The trick is, as ever, to keep alpha returns diversified.

Ian Heslop is head of global equities and manager of the Old Mutual North American Equity Fund.