Analysts continue to be positive about the US.
- Wednesday, June 13, 2018
Analysts continue to be positive about the US even after a strong 2017 and the fall offs in February and March. Dividend growth from corporate earnings is a significant contributor to investor sentiment rising. Analysts are expecting over 60% of leading US corporations to increase their dividends to shareholders this year.
Corporate earnings in the US are expected to show some significant increases this year over last providing upward pressure on share values. This will in part be due to the corporation tax deductions agreed on Capitol Hill last December. Analysts expect this tax reduction to add 7% to earnings per share growth and profits could rise by 20%. Further dividend pay-outs and share repurchases will support equity values as companies look to deploy their corporation tax reductions. The combination of earnings growth and dividend growth will offset the potential volatility in markets particularly if or when rising interest rates and inflation threaten to erode corporate profit margins.
The large corporation tax reductions and the personal tax rate reductions have provided the US economy with an additional late-cycle stimulus. The Bipartisan Budget Agreement (BBA) passed by Congress in February will further fuel growth. The BBA increases the expenditure caps for defence spending and non-defence spending to a total of US$165bn and US$131bn respectively for both 2018 and 2019. This added to new infrastructure spending has taken additional US spending to US$ 400bn. Altogether tax cuts and government spending increases will amount to 2% of GDP over two years. These US tax rate reductions and public spending plans will boost US growth and corporate earnings at a time when the US economy is already very strong. These stimuli do add a degree of uncertainty to the economic outlook as they also bring a risk of overheating and inflation. The Federal Reserve will have a difficult job balancing the need for continued growth with the control of inflation.
There is a general expectation that the Federal Open Markets Committee (FOMC) will raise rates three times this year, but this could, with additional growth expected, stretch to four.
The increase in inflation in Q1 was not only a result of higher oil prices but also a lag in inflation from 2017. Last year annual US inflation was 2.1%, it is now running at 2.5%. Some fund groups are suggesting the inflation rate could exceed 3% this year. This sort of increase will test the Federal Reserve’s new Chair Jerome Powell particularly if wages do start to accelerate. January’s average hourly earnings data was up year-on-year by 2.9% but fell back in March and April to 2.7% and 2.6% respectively. It is encouraging that there has not been a sustained improvement in wage growth.
It is a challenge for central banks, when at the end of a growth cycle and with inflationary pressures rising to get the right level of tightening to control inflation without creating a recession. Overtightening the Federal funds rate remains a risk to asset values.
The consensus of economic forecasters expects inflation to pick up in the US this year. However, inflation over the past eight years has been running behind the Federal Reserve’s inflation target of 2%. With the labour market tightening, forecasters are expecting inflation will increase. However, in most developed economies underlying monetary growth has remained low and below the rate required to generate a real surge in inflation. As long as money flow and bank lending growth remain modest, we should avoid an inflationary shock that would warrant monetary tightening and could threaten the end of the global growth cycle.
Chris DaviesChartered Financial Adviser
Chris is a Chartered Independent Financial Adviser and leads the investment team.