The latest dispatches from the U.S. economic front have been bright enough to wipe that perpetual tight smile off the face of Republican presidential hopeful Mitt Romney, whose main selling point is that he knows how to fix the ailing economy and President Barack Obama doesn’t.
Even before the loony U.S. primary season gets into full swing, the American economy doesn’t appear to be co-operating with the leading Republican’s strategy. Numbers released last week show that U.S. payrolls climbed by 200,000 in December, double the total of the previous month and well above estimates. The unemployment rate dipped to 8.5 per cent, its best level in nearly three years. More important, average weekly earnings and hours worked increased, and manufacturing expanded at its best clip in half a year. Consumer confidence climbed to its highest level in five months, and a handful of large retailers reported better sales, improved margins and enough demand to prompt a bit of hiring.
Even David Rosenberg, Gluskin Sheff’s eminent resident bear, was moved to comment that the latest U.S. jobs report “seemed to offer up a tremendous amount of good cheer to end the year” – before proceeding to uncover some of the blemishes beneath the makeup.
The latest economic soundings prompted some commentators to wonder if U.S. investors are too focused on Europe’s dire debt crisis and the slowdown in emerging markets to embrace the good news in their own neighbourhood.
But after surveying the economic and financial landscape, renowned U.S. money manager Rob Arnott says investors ought to be even gloomier.
“This isn’t a recovery,” Mr. Arnott, chairman of Research Affiliates, said the other day from his perch in mostly sunny Newport Beach, Calif. “What we had was a catastrophic recession through mid-2009 and we have been sputtering … since then.”
He points to the embattled housing market, worsening job outlook and deepening fiscal woes to back his contention that investors should be getting out their umbrellas to deal with what he calls the eventual “3D hurricane” of soaring debt and deficits and aging demographics.
On the job front, new employment is creeping into the system at a slower pace than expansion of the working-age population. In fact, the proportion of Americans between the ages of 20 and 65 with jobs is lower today, at about 75 per cent, than when the recession supposedly ended two and a half years ago.
As for the critical housing sector, there can be no sustained recovery until the enormous inventory is largely cleared. “That process has been under way for a couple of years, but it’s got a long way to go … another two to three years. It should have cleared by now. But government intervention slowed the process.”
And don’t get him started on public debt. GDP growth is vastly overstated, he argues, because the figure does not distinguish between consumption that is covered by current income and that which is financed by deficit spending. He likens it to a family with too many credit cards. The more credit they use, the higher the “family GDP.” But such expansion is unsustainable. Once they are forced to slice up their cards, their GDP must nosedive.
“We’re sowing the seeds for some pretty rocky times ahead.”
Corporate profits, too, should finally succumb to reality this year, he says. “Historically, when you have peak earnings, you also have peak optimism for future earnings. And that leads to big surprises on the downside, because the expectations are great and the reality is retrenchment.”
Surprisingly, all this does not mean Mr. Arnott is particularly bearish about U.S. equities or bonds. But neither is he bullish.
“Usually I enter a year with a much stronger view as to which way stocks are going to go. U.S. stocks could go either way. If you get a flight to safety and benign inflation … you could see stocks do rather nicely. On the other hand, if the economic turbulence creates a flight to safety not just to the U.S., but to U.S. bonds and to the exclusion of stocks worldwide, then it could go the other way.”
He has long advocated three pillars of sound investing, but most people stick with two – mainstream stocks and bonds.
He thought the ideal time to build that third pillar would come more than two years ago, when he recommended that investors build a hedge against home-grown inflation and reduce risk by diversifying into other markets and assets, including commodities, high-yield corporate bonds and emerging market debt. But he didn’t account for the overwhelming global flight to the safety of U.S. assets.
He is convinced the time for third-pillar investing is coming soon, but he acknowledges it may still be too early.
U.S. dollar assets are likely to remain favourites of haven-hunters fleeing from the storms in Europe and elsewhere for another two to three years, by which time he expects U.S. inflation will be worrisome enough to drive up rates.
“At some point, people will wake up to the fact emerging economies have drastically less debt relative to GDP than the developed economies and drastically higher yields and that the emerging markets may turn out to be a better safe haven.”
But the transition will be gradual, so the spread between developed and developing securities will be slow to narrow. “You want to be there before the spread evaporates. Right now, when there’s a flight to safety, maybe not. Maybe it’s premature. But some time in the coming year, you want to take advantage of that.”