FEBRUARY 2011                                                                                                                         Download PDF Version

Pay Attention — The USA is Awake


The USA has been jolted by the recent financial crisis. As the music, powered in the rest of the world by exports, finally stops investors should examine their current and future portfolio allocations lest they find themselves without a chair.

I was luckily enough last month to attend a breakfast at which Charles Dumas of Lombard Street Research spoke. He gave a very clear and concise outline of his view of the world, and, with his permission, I precis the main points of his thesis.

His contention is that the USA went to sleep in the early 1990s. Life had been easy for some time and the consumer had been able to buy cheap foreign imports and run up freely available debt. In fact the US consumer has assisted with the birth of a number of the world’s most successful economies from Germany in the 1950s through to Korea and Japan and, presently, China. However, the financial crisis has jolted the USA awake and it is now going to be active rather than pro-active in its economic policies.  

Momentum continues
The USA is currently running a deficit of 10.5% of national output. This deficit is being funded c.7% by the private sector (largely from surplus cash on corporate balance sheets) and 3.5% by foreigners. It is clear that the USA is not going to ‘do austerity’ in 2011 and therefore will continue to run deficits. Importantly President Obama managed to get passed not only an extension of the Bush tax cuts, but also the full write-off against tax of any capital expenditure that companies undertake in 2011. This latter point, when coupled with the large amount of surplus cash on American corporate balance sheets, should ensure significant investment in 2011 and that the US economy will arrive in the fourth quarter 2011 with substantial momentum. However, this is where the politics becomes involved and problems start. 

Politics, politics...
The Republicans took back the House of Representatives at the mid-term elections and the incoming Republican Speaker offered the following quote:

“No longer can we fall short. No longer can we kick the can down the road. The people voted to end business as usual, and today we begin carrying out their instructions.”

The Republicans do not like deficits and, once they see the momentum that the US economy starts to gather, they may well feel that they were outwitted by Obama on the tax cuts and capex write-off. They will be terrified that this momentum will sweep the President back to power. Therefore tougher negotiations around the October budget should be expected, with a knife being taken to public services.

China worst affected
Dumas anticipates the US wishing to reduce its deficit from the current 10.5% down to 3% over the next few years. The main casualty of this reduction will be the overseas balance which will be reduced from 3.5% to close to zero. In basic terms the USA will reduce its imports and it will be China, as the main exporter to the USA, who will feel the pinch the hardest.

All export driven economies must re-jig their economies in order to become domestically driven or potentially face a slowdown. China and Asia are most likely to suffer.

Conclusions
Whether one fully agrees with this line of argument the conclusions Dumas draws echo many of Clarmond’s views which we have recently been expressing, namely:

  1. 2011 is a relatively positive year for equities with 2012 looking less certain.

  2. The Emerging Market surge is exaggerated in the short to medium term - although it remains valid as a longer-term trend.

  3. Portfolios should be allocating to the USA and be investing in defensives and blue-chips with high yield.

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