After many years at rock bottom, there finally seems to be some definite upward momentum in US interest rates.
Tom Elliott is strategist at JP Morgan Fleming: “The fact that the Fed is continuing with its policy of raising rates has reassured the market that the economic recovery is on course.”
He adds: “We have a figure of 2.5% by next February. The Fed has been raising rates almost irrespective of the economic data because they want to get some normalised real rate; with headline inflation running at around 1.7% they are still negative in real terms.”
Ian Tabberer, US Investment Manager at Britannic Asset Management goes further: “We expect the Fed to come up to a neutral position in terms of interest rates but I don’t think we are there yet. Rates will probably reach 3.5-4.5%.”
There is a mix of views about the general economic outlook. Tabberer: “The re-election of President Bush has given businesses some confidence in terms of not having to reckon with large increases in tax.”
However, AXA Investment Managers commented in a recent strategy bulletin: “We have become increasingly sceptical in recent months about the outlook of US earnings for next year.” It adds: “Employment has outpaced labour force growth. It adds: To us this clearly means that corporate margins will face some headwinds in quarters to come.”
The outlook for the consumer is not particularly favourable. Grant Cowley, head of US equities at Schroders notes: “Without further fiscal stimulus the endebted consumer is losing one leg of support. The other leg of support is interest rates as it relates to mortgage refinancing. This has been a big benefit for consumers for a while but rising interest rates take away that leg of support.”
But Cowley is sanguine about prospects for the market: “moderate growth with low inflation is a good environment for the market,” he says. “The question is are they cheap enough? There is a lot of debate about what the earnings growth will be next year; predictions range from flat to 10%.”
There are some opportunities to be had in US equities, but the market is no rose garden. Investors have to tread carefully. “Equities offer value relative to bonds from our point of view,” says Elliott. “We are overweight global equities but underweight US because there are better opportunities in the equity world outside the US, especially in Japan and continental Europe where there is value. There is increasing productivity in these markets whereas in the US it is decreasing.”
Tabberer explains that we have moved on relative to last year. “The slowing rate of economic improvement is the key. When the economy was coming out of the post-war malaise it was helping everybody; that is not necessarily the case now. It is only the companies with strong business models and market share opportunities that will continue to prosper”
The oil price has taken its toll. “The best example of this is Wallmart,” notes Tabberer. “It has affected the lower end consumer because of the price of oil relative to their disposable income. As a result higher end retailers doing much better.”
He adds: “Pharmaceuticals have continued to underperform in spite of the Republican victory. Our view is that it doesn’t alter the fundamentals affecting the group; these include pricing pressure and the generic drugs.”
Cowley’s general view is optimistic: “Our general thesis is that with free cash flow margins at record highs it was inevitable at some point that that money would start to get spent. We have seen levels improve and some stocks in the industrials area have done very well so we have been overweight that sector. Companies with exposure to aerospace are also favoured. But we struggle to find value in materials. There is a lot of debate about growth in China and we have found that the valuations have become increasingly stretched.”
Overall the market seems to prefer small cap. Elliott notes: “Small cap profit growth has been stronger and will continue to be so over the next couple of quarters. This is a reflection of the cyclical bias towards small cap sectors. You don’t find many large defensives in the small cap sector.”

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