Posted: April 02, 2013
Focus on fiscal fundamentals
It's clear things are looking upKC Mathews
Sooner or later, the market looks at the underlying fundamentals to determine asset prices. Since 2009, the fundamentals of the U.S. economy have been improving. Some of the important, positive aspects of the economy often neglected by the media include corporate health, residential investment and motor vehicle sales. All of these factors are improving.
First, corporate fundamentals are strong. Companies are lean, productivity is high and margins are near record levels. Corporate earnings also are at all-time highs and
businesses, while still uncertain about the economic environment, are looking to invest the cash they have sitting on the sidelines. Additionally, corporate balance sheets have never been stronger, and because of this, earnings have outpaced the stock market performance since 2009, growing by 96 percent, while the S&P 500 has increased by 68 percent.
Clearly, monetary policy and liquidity have played a role in driving stock prices higher, but this year we anticipate earnings growth to be in the six to eight percent range. That should support high single-digit equity returns. Noise aside, sooner or later corporate earnings will be a major catalyst in moving stock prices higher.
Additionally, one of the most encouraging signs in the economy is that some of the most cyclical elements of the U.S. economy - housing and motor vehicles - are finally recovering from the recession. In fact, we forecast that both housing and automobiles will once again be major contributors to U.S. economic growth over the next few years. Historically, it has been common for residential investment and motor vehicles to comprise nearly 10 percent of real GDP. Today, that number stands at just under six percent due to the depressed nature of these markets, which means there is a significant runway for growth ahead.
The housing market peaked in 2006 as we were building 2.2 million homes a year, which created a supply problem. Today the pendulum has swung the other direction and now we have a demand problem as excess supply has dissipated. This will support increasing home prices and climbing consumer confidence.
With respect to the motor vehicle sector, during the last recession many individuals made the rational decision to delay a major capital expenditure, purchasing a new automobile, by running their current vehicles for longer. This has resulted in an all-time average age high, with vehicle stock at nearly 1 1 years, creating a significant amount of pent up demand for new and used cars. As financial and labor market conditions have improved, and as credit conditions ease, we are seeing strength in automobile demand. We believe the auto sector could be a positive contributor to real GDP for at least the next three years.
Lastly, we see global fundamentals improving. Since June 2011, there have been 345 stimulative initiatives worldwide, interest rate cuts, quantitative easing, lower tax rates and loan programs.
I believe that banks and credit are the life blood of the economy. When examining the performance of commercial bank stocks in the U.S., they returned 24 percent in 2012, yet banks in Europe were up 32 percent. The performance of bank stocks gives us some insight into the health of the banking industry. Clearly it is improving, and global banks are currently in better shape to lend money, which will support economic growth.
Additionally, as the global environment improves, U.S. corporations will ship their goods and services around the world, continuing the improvement of corporate earnings.
The fundamentals of our economy are improving, albeit slower than most expected. It’s still important to note that the fundamentals are headed in the right direction. And fundamentals matter.
KC Mathews, CFA is executive vice president and chief investment officer of UMB Bank.