Wealth Management: Strategy blog – Unloved cycle beats expectations - again
Strategy team - Kevin Gardiner and Victor Balfour (Wealth Management)
When we say short-term forecasting is difficult, it's not just false modesty. Look at Friday's provisional estimate of first quarter US GDP growth.
Just a few weeks ago it looked as if the risks were tilted towards a weak number, and with good reason: the government shutdown, the tariff tussle, Q1 seasonal quirks. But by the time of publication, estimates of the annualised quarter-on-quarter change had drifted upwards from a 1-handle to a 2. The outcome was an above-trend 3.2%.
The year-on-year growth rate, at 3.3%, was the highest since early 2015, and has only been beaten twice in the entire post-2009 expansion (which is poised to become the longest on record).
An end-quarter surge in consumer spending, and a boost from inventories and net trade (exports shrugged off trade worries even as imports fell sharply) were responsible for those initial forecasts being too gloomy.
This looks a bit erratic - it is unusual for inventories and net trade to surge together, particularly when industrial output looks to have been soft - but in a way the story of the quarter is the story of the cycle to date. Underlying expectations, plausible or not, were just too low.
We don't mind admitting we can't accurately second-guess the quarterly moves because clearly, we're in good company - and we don't spend much time on those guesses.
Nor are those moves usually much of a guide to investment returns. The strong stock market returns in the quarter partly reflect a rebound from the fourth quarter's fall, and an unexpectedly-generous Fed. GDP growth probably helped, but context usually matters more.
When it comes to underlying trends, however, it has been possible to offer a more positive assessment. Since 2009 we've suggested the consensus view of the US economy - and with it, corporate profits - has been too pessimistic. Now, not only is the sheer persistence of the upturn apparent - as noted, this summer it may become the longest-ever - but its average velocity too is looking healthier than feared.
This upswing has been accompanied by unrelenting worries about the US' ability to grow. There has been much talk of “secular stagnation”, “too much debt” and suchlike. Nonetheless, the shortfall in trend GDP growth relative to the last expansion is just 0.5% (2.3% vs 2.8%), a gap that is probably within the margin of measurement error. Within GDP, growth in real private final demand - consumption and capex together, the key drivers of private sector activity - has been little different from the last cycle (3.1% after 3.4%).
And the previous upswing, remember, was flattered by unsustainable excesses in mortgage lending and borrowing - markedly missing so far from this one.
Bottom-up tallies of corporate earnings per share have of course long since outpaced the growth rates seen in the last cycle (and not, as some suggest, because of sharecount manipulation).
After falling briefly into (unprecedented) loss in late 2008, S&P 500 companies were always going to see a dramatic rebound. Even modest economic growth would have been enough to boost EPS hugely when companies stopped passing their balance sheets through their profit and loss accounts.
As a result, we shouldn't make too much of the near quadrupling of full-year operating EPS since the GFC lowpoint. But trend profitability in this cycle's upswing has matched the last's, with the return on shareholders' funds (RoE), after (modest) inflation, at 12%. That ongoing growth in the local economy has surely helped.
Investment conclusion? All cycles end eventually. But we're trying still to keep an open mind about the duration and pace of this one - and about the downturn that will follow. Just as there were few reasons for believing the US had suddenly gone ex-growth in 2009, there are also few reasons for believing now, as many seem to, that the next downturn has to be as grim as the last.
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