Don’t trust the political debate on US growth

Taking investment advice from politicians is rarely a good idea. Political propaganda is rarely objective or relevant to the markets. Investors have to remember fundamentals, and not fiction, are the basics of investing.

With that in mind, the best strategy for US investors might simply be to turn off their televisions for the next four months. Neither the Republicans nor Democrats are likely to depict the investing environment in any way that resembles reality.

The current political tone appears vastly different than the actual tone of the financial markets. While there is no doubt that US economic growth has not been as robust as in previous recoveries, investors must be careful not to extrapolate the tepid economic performance as an all-out catastrophe.

Politicians focus on the absolutes of good and bad, whereas markets focus on the relatives of better or worse. For example, the US unemployment rate is 8.2 per cent, and there has been plenty of political discussion surrounding that unacceptably high rate. However, the US stock market has appreciated nearly 40 per cent since October 2009 when the unemployment rate peaked at 10 per cent. Clearly, the improvement in the unemployment rate has been more important to market performance than the stubbornly high absolute rate.

US political discussions rightly focus on the domestic economy. But investors must focus on the global economy. Whereas the US economy’s anaemic performance of late leaves room for improvement, investors swayed by the political rhetoric are probably unaware that the Dow Industrials and the S&P 500 are the sixth and seventh best performing equity indices in the world for the 12-month period ending June 30 (according to Bloomberg). Further, the US stock market during this period was the best performing developed market, outperformed all of the Bric markets (Brazil, Russia, India, and China), and outperformed all but three emerging markets.

Through much of the past decade, Wall Street emphasised global investing because non-US economies were outperforming the US economy, and the potential for growth was greater outside the US than in. The competitive disadvantage of the US has become a sizeable political issue. Once again, investors focusing on politics may be missing an opportunity. The Russell 2000 has the fastest projected earnings growth rate of the major equity segments in the world, and the Russell 2000 has outperformed emerging markets since the March 2009 trough. The US stock market may actually now be a “growth” market.

We see many growth-oriented themes in the US. The US consumer is directly benefiting from the rest of the world’s economic woes. Real wage growth is positive for the first time in nearly two years thanks to falling petrol and energy prices. Given a 1.5 per cent 10-year treasury note, it should be no surprise housing and construction are no longer comatose.

Small capitalisation US banks seem attractive as well. These banks are starting to benefit from the improvements in household cash flows. Asset values on their balance sheets are more reliable as housing and construction stabilise. Also, they have no exposure to the deflating credit bubbles in Europe, Asia, and the emerging markets.

US manufacturing is becoming more competitive. Whereas it is unlikely to return to its heydays of the 1950s and 1960s, lower energy costs, slower wage growth, and political stability are leading to a growing list of anecdotal evidence that global companies are incrementally locating facilities in the US.

The global credit bubble continues to deflate, yet investors remain anchored to investments and asset classes that benefited most from the artificial demand created by the credit bubble. Commodities, gold, real estate, alternatives, and other credit-related investments are likely to underperform within the context of global credit deflation.

The saying in real estate is that three things matter when purchasing a property: location, location, and location. During booms, real estate in marginal neighbourhoods performs well, but those investments tend to perform poorly once the boom ends. It’s the same in global investing: location, location, location. Emerging markets performed well during the credit boom. It is our view that they will perform poorly as the credit bubble deflates.

If markets are forward looking, the outperformance of US stocks suggests the US economy might be healthy relative to the rest of the world. It may be hard for investors to believe that US assets could dominate the markets for some time to come. Investors may have an easier time navigating this changing environment if they turn off their televisions, ignore the coming wave of political rhetoric, and focus on basic fundamentals.

Richard Bernstein is CEO of Richard Bernstein Advisors and author of “Navigate the Noise – Investing in the New Age of Media and Hype”