Permanent Value

Week in Review 12/16/13

Bruce Doole
December 18th, 2013

U.S. Growth Experiencing Mix of Headwinds and Tailwinds

In the U.S., my assumption is that we will not get a lot of valuation help on our investments. So I’m assuming in the U.S. that the recovery is transitioning to a more complex part of the recovery, not quite as easy.

There are still some very, very serious tailwinds to growth. We still have a very, very weak recovery relative to any prior cycle you can look at. By now we should be much stronger in a lot of areas, and we’re not, suggesting to me that there is more to go. You have to get the housing cycle better than it is. You’ve got to get the auto cycle better than it is. There’s an enormous amount of pent-up demand for automobiles, if you look at just the age of the fleet. There’s a huge pent-up demand for housing, if you just look at the household formations and so forth. So there’s still a lot of room to go there in my view.

Consumer spending has been good, but it hasn’t been compelling. Unemployment rate is extremely high relative to prior cycles. We all know that it’s 7.3%, but it needs to come down, and as it comes down — and I believe it will come down — you’re going to have an environment where there’s more money that goes into the system. The consumption cycle is going to start doing better. So I believe that’s going to be a tailwind.

And then if you look more on the industrial side, there are really no excess inventories out there that often can cause cycles to happen. If you look at loan growth, it’s been quite sluggish. So there are no excesses out there. It’s very hard to get a cycle until you get excesses, and there clearly haven’t been. So to me, that argues that the fundamentals of the economy still have a ways to go.

The top of the list of headwinds is the rate environment, and rates are going up. I don’t know how fast, I don’t know when they’ll really start rising, but in my view they should be rising. If we’re in a stronger economy, rates should be going up. It’s a natural headwind that should be occurring and actually indicates a strong economy if you have demand for money going on.

You’ve got the dollar that’s been very strong and may continue to be pretty strong, but we certainly aren’t going to get a lot of help [from] a weaker dollar in terms of any export markets. Finally, the valuation issue on the market is such that whatever year you’re looking at, but 16, 17 times earnings on a market that’s growing — but it’s not expanding as rapidly as it has in prior years — I think is a fair valuation. I don’t think it’s overvalued, but I don’t think we’re going to get a valuation increase.

One thing I think we should also add is that if you look at where money is parked, there’s still an enormous amount of money parked in cash. The market is willing to take more risk, investors are willing to take a little more risk, but they certainly aren’t back to levels that would suggest they’re putting all their money into equities. And until you get that environment, it’s hard to have a peak in the market.


Source: American Funds, Claudia Huntington