Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 51

The US recovery will surprise on the upside

Many commentators suggest that US economic growth will remain subdued. However, a number of indicators are suggesting it will surprise on the upside. If it does, there will be significant implications for policy, investment markets and portfolio construction.

In our opinion, a wide range of indicators point to a likely acceleration of US economic growth in 2014:

  • Improvement in the US labour market is real – Jobs are being created at a rate of 2.1 million p.a., the unemployment rate has fallen to 6.6% and average weekly earnings are rising. Although some economists believe that declining labour force participation indicates that unemployment is worse than headline figures suggest, it is important to note that participation has been naturally declining since 2000 as a result of the ageing of the US population, not just since the financial crisis.
  • Housing will help drive the economy - Recoveries in key indicators such as home prices, housing starts and mortgage debt are encouraging. We believe that private residential fixed investment remains depressed at around 1.5% of GDP, below its long run level (excluding multiplier effects) and will inevitably revert to more normal levels. Furthermore, the share of residential mortgages in negative equity has fallen considerably over the past couple of years which may encourage more households to draw down on home equity for consumption.
  • Credit conditions are favourable – Household debt has fallen considerably from its peak of 96% of GDP in 2009 to 77% today (the same as 2003), providing scope for rising consumption in the future. Furthermore, US banks are well positioned to deliver credit growth with common tangible equity to common tangible asset ratios having approximately doubled since 2008.
  • The competitive position of the US is improving – US manufacturing hourly labour costs have fallen significantly relative to other countries (in USD terms) over the past 10 years. The shale boom has also provided the US with a massive energy cost advantage, while also helping to reduce the trade deficit.
  • Fiscal drag is decreasing - The government expenditure component of GDP has been contracting in recent years following the large stimulus provided during the financial crisis. Economists estimate that expenditure cuts and payroll tax increases reduced GDP growth by 1.5-2.0% in 2013. However, a dramatic recovery in the federal budget deficit suggests there is declining pressure for further cuts, and the fiscal headwind is expected to be just 0.5% in 2014.

It is our view that, in the absence of a material negative shock, the US economy will experience accelerating economic growth over the next 12 to 24 months, and is likely to surprise on the upside.

What does a US upside surprise mean for markets?

A strengthening US economy will require the Federal Reserve to reduce the unprecedented monetary policy support it has provided since the global financial crisis in order to ward off excessive risk-taking in the financial system and to protect against future inflation. The Fed’s exit from QE poses risks for equity and other asset markets (particularly currency and bond/credit markets) as long term interest rates start to move closer to pre-crisis levels, potentially causing a dramatic redistribution of global money flows. We continue to view the Federal Reserve’s exit from QE as the major current investment risk.

A faster-than-expected US economic recovery, with strong demand for credit, could lead to high inflation as banks start to lend from their massive pool of excess reserves, currently USD2.4 trillion. While the Fed has a number of tools that could reduce the size of excess reserves or neutralise their impact, there is no reliable historical precedent that can guide investors (or the Fed itself) as to what will happen to markets as QE unwinds.

We continue to believe that there are two main scenarios that could play out:

  1. An orderly unwinding of QE. This is our base case, predicated on a steady but not sharp US recovery, with a gradual increase in credit demand, and contained rises in short and longer term US yields. Under this scenario we would expect the US 10 year Treasury yield to rise to around 4.5-5.5% over the next one-and-a-half to two-and-a-half years. We would expect elevated market volatility and potentially some dramatic re-pricing of certain asset classes. This scenario does not overly concern us from an investment perspective.
  2. A disorderly unwinding of QE. Under this scenario, longer dated bond yields could start increasing rapidly as investors lose confidence in the Fed’s ability to exit QE in an orderly manner (it is not unthinkable that US 10-Year Treasury yields could hit 8-10% over the next one-and-a-half to two-and-a-half years). This could lead to massive market dislocations, including large and rapid falls in asset prices, major moves in currency markets and the withdrawal of liquidity from certain emerging markets, as well as increase global systemic risk. A rapid rise in longer term US interest rates would also be highly likely to drive up longer term interest rates around the world, potentially re-igniting the European sovereign debt crisis.

We assess the risk of a disorderly unwinding of QE to be a ‘fat tail’, or low-probability, scenario. However, as we have repeated on many occasions, low probability does not mean zero probability.

Implications for portfolio construction

Although a rise in US economic growth presents a tailwind for businesses positively exposed to the US economy, it is important to recognise that economic growth is not the most important determinant of equity market returns. Indeed, we believe long term interest rates have historically been more important to aggregate stock market performance; higher interest rates will reduce valuations via the discount rate on companies’ expected future cash flows, leading to lower equity price-earnings multiples in aggregate. Investors should be asking themselves ‘what effect will higher interest rates have on markets?’ We are paying close attention to this critical question.

Hamish Douglass is CEO and Portfolio Manager at Magellan Asset Management. This material has been prepared by Magellan Asset Management Limited for general information purposes only and must not be construed as investment advice. It does not take into account your investment objectives, financial situation or particular needs.


Leave a Comment:



Trump’s fiscal stimulus threatens stocks

Stock market winners 10 years on

Why China’s property market matters


Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

Three all-time best tables for every adviser and investor

It's a remarkable statistic. In any year since 1875, if you had invested in the Australian stock index, turned away and come back eight years later, your average return would be 120% with no negative periods.

The looming excess of housing and why prices will fall

Never stand between Australian households and an uncapped government programme with $3 billion in ‘free money’ to build or renovate their homes. But excess supply is coming with an absence of net migration.

Five stocks that have worked well in our portfolios

Picking macro trends is difficult. What may seem logical and compelling one minute may completely change a few months later. There are better rewards from focussing on identifying the best companies at good prices.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

Let's make this clear again ... franking credits are fair

Critics of franking credits are missing the main point. The taxable income of shareholders/taxpayers must also include the company tax previously paid to the ATO before the dividend was distributed. It is fair.

Latest Updates

Investment strategies

Joe Hockey on the big investment influences on Australia

Former Treasurer Joe Hockey became Australia's Ambassador to the US and he now runs an office in Washington, giving him a unique perspective on geopolitical issues. They have never been so important for investors.

Investment strategies

The tipping point for investing in decarbonisation

Throughout time, transformative technology has changed the course of human history, but it is easy to be lulled into believing new technology will also transform investment returns. Where's the tipping point?

Exchange traded products

The options to gain equity exposure with less risk

Equity investing pays off over long terms but comes with risks in the short term that many people cannot tolerate, especially retirees preserving capital. There are ways to invest in stocks with little downside.

Exchange traded products

8 ways LIC bonus options can benefit investors

Bonus options issued by Listed Investment Companies (LICs) deliver many advantages but there is a potential dilutionary impact if options are exercised well below the share price. This must be factored in.


Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

Investment strategies

Three demographic themes shaping investments for the future

Focussing on companies that will benefit from slow moving, long duration and highly predictable demographic trends can help investors predict future opportunities. Three main themes stand out.

Fixed interest

It's not high return/risk equities versus low return/risk bonds

High-yield bonds carry more risk than investment grade but they offer higher income returns. An allocation to high-yield bonds in a portfolio - alongside equities and other bonds – is worth considering.



© 2021 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.