Underlying US story positive, says Merrill Lynch Wealth Management’s Johan Jooste
Johan Jooste, chief market strategist at Merrill Lynch Wealth Management EMEA, says that although recent US GDP data disappointed, the underlying economic trends point to stronger labour market and activity data.
The US economy contracted by 0.1% in the last quarter of 2012, leaving some investors concerned that the world’s largest economy is half way to recession. We advise against
reading too much into the negative number. In fact, given the details of the GDP report, as well as additional US economic data released last week, we feel comfortable that the US economy is continuing to grow at around 2%.
The primary culprits for the contraction were a significant decline in government spending and a large reduction in inventories. With the reduction in government spending and inventory drawdown each subtracting approximately 1.3 percentage points, real final private demand was actually far more robust.
Private consumption grew by 2.2% in the fourth quarter emphasising our view not to underestimate the US consumer. Encouragingly, investment also increased quite healthily. We remain of the belief that over the coming years,
strong investment growth will be needed to sustain the U.S. recovery.
Further evidence of the persistence in the cyclical recovery was seen in both labour and manufacturing data. The Institute of Supply Management manufacturing Purchasing Managers’ Index (a key gauge of US activity) rose to its highest level since last April, with forward looking components also making gains. Although the unemployment rate rose to 7.9%, non-farm payrolls rose by 157,000 in January, with upward revisions of roughly 600,000 additional jobs over the last two years. A continuation of monthly non-farm payroll additions of nearly 200,000 per month through 2013 should be supportive in reducing the unemployment rate gradually.
While the underlying growth rate in the US is healthy – and far ahead of that experienced in Europe – it is unlikely to lead to any change in monetary policy stance by the Federal Reserve. Last week, the Federal Open Markets Committee maintained its current stance of undertaking $85bn monthly purchases of mortgage-backed and Treasury securities. Although the committee acknowledged that financial strains had eased, it “continues to see downside risks to the economic outlook”. Additionally, with declines in the unemployment rate to be only gradual, and with inflation pressures falling, we continue to expect the Fed to maintain its current policy stance through at least all of 2013.
Combining the improved economic data with the decision by the Senate to delay the debt ceiling for at least a few months, risk assets – especially equities – continue to move higher.
While we are constructive on equities through 2013, we have noted recently our concern of a short-term modest correction as investors appear to be becoming complacent. Our view here has not changed. We continue to look for pull-backs in markets to add to equity weights.
In the meantime, we are looking at regional equity allocations. So far our preference has been emerging markets and the eurozone. Given the almost universally positive tone coming from US data, we have been looking more recently to reduce UK equities in favour of the US Regarding currencies, we believe it is a matter of time until the US dollar begins to appreciate against the euro. We acknowledge that while the market remains in purely “risk-on” mode, the euro may edge higher. Yet we believe the general trend is for a weaker euro, given the diverging growth rates between Europe and the US and that a stronger euro begins to weigh on eurozone exports and inter-eurozone financial conditions. On the fixed income side, the stronger economic data continues to justify our negative outlook on core sovereign bond yields.